Back to school: Saving for a private education

As kids head back to school after the summer break, advisers recommend investment strategies to put a child through private education.

Peter McGahan, managing director, Worldwide Financial Planning:

There are different views taken by parents on saving. Some like to create a separate 'pot' for each area (school, holidays, weddings etc). Others like to save in one tax efficient area and then draw on that for whatever life throws at them.

Either way, the two key issues are tax efficiency, and careful management of the funds, especially as the child gets closer to using the capital.

Naturally an Isa is the most tax efficient way to save for the future, with all gains being free from capital gains tax. Access is immediate and such schemes rarely have a product charge that limits access to the capital.

As most investors rarely use their capital gains tax allowance, a unit trust / Oeic could also be used. Each parent has an annual allowance of £10,100 and this gain is free of capital gains tax. This is easily the most underused allowance with investors often bundled into expensive and tax inefficient investment bonds on a promise of tax deferred income which is often marketed as 'tax free'.

Access to the cash is everything, so often parents/grandparents will separate the pots to mature at different periods of time in the future. This is largely down to risk. For example, a parent might put aside money at birth in lower risk assets such as index linked gilts to mature for the earlier years. They might then begin saving monthly in a higher risk/potential growth area for the later years.

Where an investor has less time for their capital to grow, there is naturally less time for it to recover in the event of a marked fall. The potential for loss is always broadly equivalent to the potential for gain.

Parents, mindful of that, will know if they invest on a monthly basis, they can take much of that risk out. Whilst investments vary from a risk point of view, this can be an advantage. If there are marked falls in a price of an investment, a parent who is investing monthly will capitalise on that.

An investment such as a unit trust simply buys c60-100 stocks and shares giving the investor a wide spread of risk. These shares are all pooled together and an investor simply buys a 'unit' in the fund. However should there be a large fall in the market, the monthly investor is now buying these at a discount, catapulting the value of the investors' capital when the market returns.

Adrian Lowcock, senior investment adviser, Bestinvest:

Planning for school fees is something couples need to consider from the day their child is born if not before but sadly no product is currently available to meet this specific need. Like any other financial exercise the purpose of planning is to meet an uncertain liability at some point in the future.

Some schools now offer pre-paid options which are effectively the present value of future amounts (not guaranteed to meet fees but to generate a sum which will hopefully do so). The terms may be attractive especially as schools look to shore up their finances. Discounts are offered in the region of 3%-5%. Call the school to get a quote.

Schools may also have charitable status to avoid tax on their investments. However, this status may be at risk and fees may increase if they need to offer more bursaries to satisfy charity commission.

Most parents will have a reasonably long investment horizon so consider using your ISA allowances to avoid tax on any investment. With limits rising to £10,200 for all next year these could become very power tools. With such a long time horizon, consider growth over income, you can get £10,100 tax free growth this year and it usually rises each year. Plus tax on any gain above that is at 18%.

Before you make any decisions, do your sums, find out current costs and school fees. Ask what the recent rises in prices have been and what they are likely to be going forward. It is also worth asking for a discount for the second child as this will help reduce costs significantly.

Ask for help

You could ask the child's grandparents to provide financial support. This could be good inheritance tax planning for them as regular gifts from their income could be exempt from inheritance tax under the ‘gifts from normal expenditure rules'.

Nursery costs

School fees are only part of the picture. There are costs for nursery and pre-school, which could run to approximately £10,000 per annum. It is important to start saving for these as soon as possible.

University fees

After school, there is university. It is worth looking at child trust funds to help absorb some of these costs. The Government will contribute £250 at birth and a further £250 on your child's 7th birthday. Family and friends can add £1,200 per annum. This can be invested or saved as cash to grow tax free until the child ‘s 18th Birthday.

Investments

Previously many parents used zero dividend preference shares with a set maturity price and date. However, there are now too few available to construct a portfolio of shares with maturity dates to match when the fees become due. There is an alternative. Absolute return funds have been increasing in popularity and supply. Instead of a fixed maturity they aim for a constant level of return in all market conditions. Therefore a portfolio of these funds could be constructed with a set growth rate to ensure that the returns are able to cover the fees.

Martin Bamford, chartered financial planner, Informed Choice:

The total cost of private education, once you take inflation and additional expenses into account, can result in some eye-watering figures that even the wealthiest parents find hard to swallow. The first step in devising an investment strategy for this goal is to properly quantify the target amount required and the timescales involved.

Investing for the cost of private education differs from many other investment strategies because it combines an accumulation and decumulation phase, whereas most investment advice usually focuses on the former ahead of a specific goal.

This combination of phases means an absolute savings target is more challenging to calculate, with ongoing contributions to the cost of education typically available during the decumulation phase to supplement investment withdrawals.

Once calculated, the length of the accumulation phase will largely drive the asset allocation decisions, along with the level of risk the investor is prepared to take and how much risk they actually need to take given their financial resources. The longer the investment time horizon, the better, as the money can remain invested for longer to reduce the investment required to hit a specific target. Starting these investments before a child is born is becoming increasingly common.

Money invested for the longer term can also benefit from greater exposure to more volatile asset classes, allowing the parent to ride out any short term market volatility whilst potentially benefiting from higher investment growth.

The degree of investment risk that parents wish to take when investing to meet the cost of private schooling will often differ from their established risk profile for other financial objectives. It is not unusual for parents to want to take less risk for this particular objective, although assumptions can be a dangerous thing to make, so a thorough assessment of an attitude towards investment risk, reward and volatility for this financial objective is essential.

Any investment strategy for this objective needs to be combined with a wider financial plan, and that must include financial protection.

A properly constructed investment strategy, regularly reviewed to keep things on track to meet predefined objectives, can be quickly derailed by the impact of ill health or death on earnings. If the parents have capital to invest at outset, the need for financial protection is usually lower than when investments are made from disposable earnings, although it should be assessed in all cases.

Jason Witcombe, chartered financial planner, Evolve

If you are positively rolling in money, by all means pay the full £100 p/m into a Child Trust Fund for your children, put money into Premium Bonds, Children's Bonus Bonds and maybe even set up a pension for them - according to HM Revenue & Customs, about 60,000 minors now have pension plans!

However, where affordability is a consideration, our view is that parents should think very carefully before tying money up in their children's names. For example, a Child Trust Fund isn't accessible until the child is 18 so it is not much use if you need money to pay for school fees. Furthermore, at 18 the child has complete access to the money. How comfortable would any parent be in the knowledge that their child could access a potentially significant pot of money at 18 with no strings attached? Clearly, a pension is tied up for much longer still.

Our view is that parents should focus on making their own finances as efficient as possible. This will depend entirely on their own financial position but could mean mortgage and other debt repayment, saving into ISAs, investing in pensions and making use of employer-sponsored share schemes such as Save As You Earn Schemes. Someone with an attractive offset mortgage might take the view that they will fund school fees through the mortgage and pay into a pension alongside this, with the view that the Pension Commencement Lump Sum pays off the mortgage.

The important thing is to make sure that money is available to them when they need it. Therefore, every last penny shouldn't go into a pension even if it happens to be the most tax-efficient investment they could make, because it doesn't give enough accessibility. Parents should try to map out the future direction of their finances, focusing on assets, liabilities, income and expenditure. We do this by using a detailed Lifetime Cashflow Analysis Model with our clients but you can put something basic together using Excel. Once that is done, you can see what the impact of your future liabilities (e.g. school fees and university) fees will be and then structure your finances around these goals.

At the end of the day, education fees are just an expenditure item like any other yet the financial services industry often tries to tell people that they need specific "products" to save for these. They don't. All they need is a strategy.

Andrew Merricks, head of investments, Skerritt Consultants

The key to investing for childrens' education is flexibility in my opinion. I have never gone for products that mature upon a certain date or at a certain age. I tend to treat this kind of investment as any other - determine your aims and objectives, set out a timescale around which to meet them, then invest in funds that match your risk appetite allowing as much freedom as possible to change your mind or strategy should one of your chosen funds disappoint you (as they inevitably will).

Your strategy will differ probably depending upon whether you are drip feeding the investment vehicle monthly or starting with a lump sum. Often people combine the two so you may begin with the lump sum in something such as the Invesco Perpetual Distribution Fund Accumulation units to benefit from the compounding effect of reinvested (above average) dividends, and couple this with monthly contributions into a higher risk yet potentially more rewarding fund such as an emerging markets one.

I tend to leave ISAs for individuals' retirement planning rather than education as the effect of tax free income in retirement is more beneficial than capital withdrawals to fund fees, so a simple OEIC structure should suffice for education planning. As with any longer term investment, the outlook will change as the plan progresses so you should be free to switch into alternative funds as opportunities arise. It goes without saying that you de-risk as the time approaches to draw upon the funds.

Then just sit back and hope that your kids play their part by passing their exams!

Mark Loydall, director, Cambourne Financial Planning Limited

School fees planning is about having an overall investment strategy and then adding in a bit extra to allow for school fees. Whatever you decide to do it is important to understand about products that can be used and the options available.

Offset mortgages - saving the school fees money in a savings account related to the offset mortgage is often a popular option. It suits many people as it means the money is working for them whilst at the same time being set aside for their child. The return is known (as it is effectively the mortgage rate) and there is very little risk involved. Clients especially like this when they get their offset mortgage statements that show the effect of saving the money for the school fees; it tells them how much mortgage interest they have saved.

Another option is structured deposit type investments. These have a fixed life and need to be used cautiously, however because they are deposits they carry less risk than many of the structured products available from the High street. They suit some people who are putting a lump sum aside for school fees that they expect to arise in the future. They do lack flexibility however some clients are prepared to accept this in return for the security they provide.

The final option clients use is general savings vehicles such as stocks and shares ISAs and unit trusts. These are very flexible and can be used for any purpose and therefore suit the approach most clients want which is about having as many options as possible. They have the added flexibility of being able to hold a wide variety of investment that suit a wide variety of attitudes to risk.