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Investment Bonds – gifting to children and planning for education fees

Introduction

This briefing sets out how investment and capital redemption bonds can be used by investors who are considering school and university fees planning.
 

Core considerations  

  • HMRC will seek to assess chargeable event gains on the beneficiary, unless the settlor of the trust is the child’s parent, and the beneficiary is under 18 years.

  • Withdrawals using the 5% tax deferred allowance could be considered for school fees planning, while the child is a minor.

  • Full surrender of one or more segments could be considered for university fee planning for adult-children.
     

Contents

Why use a bond to fund school and university fees?
University fee planning
School fees planning using an absolute trust
School fees planning using a discretionary trust


Why use a bond to fund school and university fees?

The desire to send children and grandchildren to private school or attend university will often mean that investors will need to consider how best to fund this. The average cost of school and university fees has risen considerably. Advanced planning will help investors understand which investments can be used to help fund this and how the fees can be paid in the most tax efficient way. 

Bonds only need to be assessed for income tax purposes when there is an encashment from it. The bondholder can control when this happens. This can help make the most of available tax allowances.


University fee planning

A bond can be purchased with the intention of using its proceeds to help fund future university fees and provide financial assistance that a child or grandchild may need during their time at university.

A common approach for this type of planning, is for the bond or one or more segments to be assigned to the adult child or grandchild. Following the assignment the adult child can encash the assigned segments to pay their university costs and expenses.

If the assignment is a gift, it will not be a chargeable event. However, it would be a PET for IHT purposes.

An encashment made by the child or grandchild will be a chargeable event. Any gain arising because of this will be assessed on them and their tax position. They can utilise any unused tax allowances before determining if there is any tax to pay on the encashment from the policy.  

For example

10 years ago, Sam and Jo invested £50,000 into an offshore bond with 100 policy segments (£500 per segment). They have a daughter Terri, who is attending university. The bond is to be used to cover the university fees and some of her living expenses. The surrender value of the bond is currently £80,000 (£800 per segment). Sam and Jo have agreed to give Terri £20,000 each year whilst she is at university.

Each segment is worth £800 and so 25 segments would need to be assigned to Terri to make up the first year’s amount of £20,000. The assignment is a gift and is not a chargeable event.  

Sam and Jo have made a PET of £10,000 each. When Terri encashes the 25 segments there is a gain of £7,500 (this is because each segment has grown in value by £300, multiplied by 25 segments is £7,500).

If Terri has no other income the chargeable gain is less than her total income tax allowances available (in 2024/25) and no tax would be payable.

Sam and Jo could repeat this each year and provided the gain is less than £18,570, and Terri has no other income, no tax will be payable.

 

School fees planning – using an absolute trust

An absolute trust can be used where the beneficiaries are known and don’t need to be changed in the future. A gift into an absolute trust is a Potentially Exempt Transfer (PET) for Inheritance tax (IHT) purposes and will generally fall outside of the estate after 7 years.  

If there is a chargeable event gain while the bond is in trust, it will generally be assessable on the beneficiary unless the trust was established by the parents. In this situation the parental settlement rules will apply, and the chargeable event will be assessable on the parents, where the income from the trust, including any chargeable event gains, is £100 or more. However, if the grandparents are the settlor of the absolute trust the chargeable event gains will be assessable on the beneficiary, regardless of their age. 

It is not possible to assign policy segments to a minor-child. To release funds to facilitate the payment of the school fees, the trustees could partially encash (also known as a partial surrender) some of the bond by using the annual 5% tax-deferred allowance. 

Trustees can encash up to 5% of each premium paid, each policy year, without incurring an immediate liability to income tax. The tax deferred allowance in respect of each premium paid stops accruing once 20 policy years have elapsed from the policy year in which the premium was paid. Any unused allowance in respect of the premium can still be carried forward for use in policy year 21 onwards. However, any excess withdrawal above the 5% tax deferred allowance will be a chargeable event gain and will be assessable to income tax. 

For example 

Jack and Sheila are grandparents to Paul. They want to invest £100,000 into an offshore bond towards the cost of funding Paul’s school fees from age 10 to 18 (8-year period). An absolute/bare trust is established. 

The school fees are £15,000 per year and part surrenders of £15,000 are taken each policy year. The withdrawal each year will consist of the 5% tax deferred allowance facility providing £5,000 and the balance of £10,000 constitutes the chargeable event gain which as it falls within Paul’s personal income tax allowances mean the gains are tax free. 

 

School fees planning – using a discretionary trust

A discretionary trust gives the trustees more flexibility than an absolute trust of who can benefit, when and how much they will be paid. 

Where the trust provisions include children or grandchildren as a class of beneficiary, this would also include grandchildren who were not born at the time the trust was created.  

Most discretionary trust provisions do include an option to appoint capital to a beneficiary. This is important when using a bond because a bond is a capital asset and encashments are paid as capital. Before considering the option to use a discretionary trust, the trustees must determine if capital can be appointed to a beneficiary.

Before the fees are due, the trustees complete a deed of appointment of capital in favour of the beneficiary. It is usual for capital to be appointed as a cash sum, or some trusts may allow individual segments to be absolutely appointed in favour of the beneficiary.

The trustees remain the legal owners of the policy, however by appointing capital, they are creating an absolute interest in favour of the beneficiary.

Once the capital is appointed to the beneficiary, the trustees encash this amount from the bond. The encashment proceeds can be used to pay the school fees.

Similarly to the tax position of an absolute trust, which is explained above, the parental settlement rules will apply if one or more of the parents are the settlor(s). However, where the settlor is someone other than the parent, such as the grandparent, the beneficiary will be assessable to tax on the chargeable event. The beneficiary can make full use of their allowances and reliefs before any gain is taxable and top slicing relief is available to them. 

The gift into the discretionary trust is a Chargeable Lifetime Transfer (CLT). The absolute appointment in favour of the beneficiary is an exit from the discretionary trust. This should be assessable as an exit charge from the trust.
 

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