School Fees Planning: Trusts, Bonds, and Grandparental Giving

Private school fees in the UK — and international schools abroad — represent a significant recurring expenditure for many families. From January 2025, VAT at 20% applies to independent school fees across the UK, further increasing the cost. For high-net-worth families, the question is not simply whether they can afford the fees, but whether they can meet them in a tax-efficient manner, preserving wealth for future generations rather than paying fees from fully taxed income.

This guide covers the main planning approaches: bare trusts for children, the legacy of pre-2006 accumulation and maintenance (A&M) trusts, offshore investment bonds in trust, assigning onshore bonds to grandparents, and direct grandparental giving strategies. It does not constitute legal or tax advice; individual circumstances vary significantly.

The Parental Settlement Rules: The Core Obstacle

Before exploring any school fees planning structure, the parental settlement rules must be understood. These rules prevent parents from reducing their tax bill by putting income-producing assets in a child's name.

Under ITTOIA 2005 s629, income arising from a settlement made by a parent is treated as the parent's income if it is paid to or for the benefit of a minor child (under 18 and unmarried) of the settlor. This means:

• A parent who places cash in a savings account in their child's name cannot claim the child's personal allowance against the interest.
• A parent who settles shares on a bare trust for a minor child is taxed on the dividends as if they were the parent's own.

The rule applies to income paid to or for the benefit of the child. Crucially, an exception applies where income is accumulated (not paid out) within a trust during the child's minority. If income is accumulated and the child receives the accumulated fund only when they become an adult, the parental settlement rule does not apply to the accumulated income.

This exception was the foundation of the accumulation and maintenance trust.

Pre-2006 Accumulation and Maintenance Trusts

Before the Finance Act 2006, accumulation and maintenance (A&M) trusts enjoyed highly favourable IHT treatment: they were outside the relevant property (periodic charge) regime if they met certain conditions relating to the age at which beneficiaries became entitled to the trust fund. A&M trusts were commonly used for school fees and university funding.

The Finance Act 2006 removed the special IHT treatment for new A&M trusts. Trusts created after 22 March 2006 no longer benefit from the favourable rules — they fall into the relevant property regime and are subject to 10-year anniversary charges and exit charges.

Trusts created before 22 March 2006 under the old A&M rules retain their protected status, provided they have not been changed in a way that takes them out of the transitional provisions. Many pre-2006 A&M trusts remain in existence and continue to provide school fee funding for younger generations.

For new planning, however, an A&M trust is not available. The alternatives are bare trusts, discretionary trusts, and investment bonds.

Bare Trusts for School Fees

A bare trust holds assets in the trustee's name for the absolute benefit of a named minor child. The child is the beneficial owner — they have a fixed, vested entitlement. On reaching adulthood (18), the child can demand the assets.

Tax treatment of bare trusts:

• Income is treated as the child's income for tax purposes — subject to the parental settlement rules above.
• Where the bare trust is funded by a grandparent, the parental settlement rules do not apply (they only catch parental settlements). The child's own personal allowance (currently £12,570) can be used against income.
• Capital gains are assessed on the child, not the trustee. A child has their own CGT annual exemption (£3,000 from 2024/25).

Practical uses: a grandparent can establish a bare trust invested in an ISA-like portfolio for a grandchild. Income can be drawn tax-efficiently (within the child's allowances) to fund school fees. Alternatively, the bare trust can invest in growth assets, with minimal income, and the fund is encashed as needed to pay fees (CGT allowance used each year).

Limitation: because the child has a vested entitlement, the assets cannot be redirected if circumstances change. On reaching 18, the child owns the assets outright and can spend them as they choose. This lack of flexibility concerns many parents.

Offshore Investment Bonds in Trust

An offshore investment bond is a non-income-producing investment wrapper. It does not produce taxable income or CGT during accumulation (technically, the "profits" are deferred until a "chargeable event" — withdrawal, surrender, or maturity). This makes offshore bonds attractive for school fees planning because the parental settlement rules apply only to "income" — not to the deferred gains within a bond.

The structure typically works as follows:

1. A parent settles an offshore bond into a discretionary trust for the children.
2. The trust can make partial withdrawals (up to 5% of the original premium per year without triggering a tax charge — the "5% annual withdrawal allowance").
3. Withdrawals within the 5% allowance are used to pay school fees.
4. When fees are no longer required, the trust retains the bond until appropriate — for example, until a beneficiary becomes a higher-rate taxpayer and can claim top-slicing relief, or until they become a non-UK resident.

Tax advantages:

• No annual income tax during accumulation.
• Withdrawals within 5% are tax-deferred (not permanently exempt, but deferred until the bond matures or is surrendered).
• The discretionary trust provides flexibility to adjust distributions among multiple beneficiaries.

Tax risks:

• The bond will eventually be subject to a chargeable event. Good planning involves timing the chargeable event when the policyholder (or beneficiary) pays tax at the lowest available rate, or when top-slicing relief is available.
• Discretionary trusts are subject to 10-year and exit charges. The trust fund must be monitored for periodic charges.
• Offshore bond gains in trust are subject to trust income tax rates (45% for income, 39.35% for dividends). If gains are appointed to a beneficiary, the rate reverts to the beneficiary's marginal rate.

Onshore Bond Assignment to Grandparents

An alternative approach for onshore (UK) investment bonds involves assigning an existing bond from a parent to a grandparent. The tax consequence is that on assignment the gain is not triggered — assignment at no cost is not a chargeable event (ICTA 1988 / ITTOIA 2005 provisions on assignments). Thereafter, withdrawals from the bond are assessed on the grandparent as the new policyholder.

If the grandparent is a basic-rate taxpayer (or a non-taxpayer), this can significantly reduce the income tax on bond gains compared with the position where the parent (as a higher-rate taxpayer) held the bond.

Caution: HMRC scrutinises artificial assignment strategies. The assignment must be a genuine and permanent transfer of the policy. HMRC has rules preventing "bed and breakfasting" of bond gains via assignment to a lower-rate taxpayer.

Grandparental Giving: Direct Contributions

The simplest approach is for grandparents to make direct payments towards school fees. Direct payments to an educational institution (on behalf of a child) may be treated as regular gifts out of income, which are exempt from IHT immediately if they satisfy the conditions:

• The payment is made from the grandparent's income (not capital).
• It is part of a regular pattern of expenditure.
• It does not reduce the grandparent's standard of living.

Regular school fee payments made by financially comfortable grandparents can be immediately exempt for IHT purposes, reducing the grandparent's taxable estate with each payment.

Where capital rather than income is used, the gift is a potentially exempt transfer (PET) — exempt if the grandparent survives seven years.

VAT on School Fees from January 2025

Following the Finance Act 2025, independent school fees across the UK are now subject to 20% VAT. This increases the pre-tax cost of planning — a fee of £20,000 per annum now requires funding of £24,000. School fees planning structures must be sized accordingly.

How Global Investments Can Help

Global Investments advises families on school fees planning as part of a broader wealth planning review. We model the tax-efficient funding of school fees across different structures — bare trusts, offshore bonds, direct grandparental giving — taking into account each family member's income tax position, IHT exposure, and investment objectives.

We are experienced in administering offshore investment bonds in trust and in advising trustees of legacy A&M trusts on their ongoing obligations.

This guide is for general information only and does not constitute legal or tax advice. Tax rules are complex and subject to change. The value of investments and income from them can fall as well as rise. Past performance is not a guide to future performance.