How Parents Can Prepare for VAT on School Fees

The new Labour government has announced it will introduce VAT at the standard rate of 20% to independent school fees from 1 January 2025.

There are currently approximately 2,500 private schools educating around 7% of all pupils in the UK. The average fee per child per year is £16,656, according to the ISC Census Report 2023. Children with special needs with education, health and care plans (EHCPs) won’t be affected by the change.

Up to this point, independent schools have been exempt from VAT. So, the new initiative could mean a 20% increase in fees. This may cause financial problems for parents who already find sending their children to private schools a strain.

What steps will schools take?

Not all schools will pass the increase on directly by raising fees by 20%. Some may cut staff costs, reduce facilities, lower profit margins or try to attract wealthy foreign students.

Others may increase their fees but not by the full amount. As schools can still deduct VAT when buying goods and services, they could offset it from fees, too.

But, regardless of what steps they take, many independent schools may potentially close because of this change.

The reasons behind the proposal

The initiative has been proposed to keep the government’s manifesto pledge of generating additional revenue of £1.3-£1.5 billion. The stated intention is to increase state school funding and pay for an extra 6,500 teachers.

However, the proposal could result in a mass exodus of approximately 40,000 students from independent to state schools. The result could be a reduction in the anticipated revenue by about £300 million annually.

So, if you have children in private education, what strategies can you adopt to plan for the likely increase in fees? We take a look at some proactive ways.

Plan ahead

One idea was that parents could pre-pay school fees in advance to avoid paying the VAT. But the government has cracked down on that and said the tax will apply to all payments for the January term made from 29 July 2024 onwards. You can still explore other means, such as:

Budgeting

Just as with any anticipated expenditure, check your household budget. Calculate the impact of such a cost increase and what savings you might need to make. You may have to review non-essential expenses like subscriptions, gym membership, a second holiday or a new car.

You could also enquire whether the school might offer credit facilities to help you spread the fees over a more extended period. You could also consider ways to increase the family income, such as going back to work, working more hours or starting a side hustle.

Gifting

Family members, like grandparents, may want to contribute towards school fees through gifting. This could be part of their inheritance tax (IHT) planning strategy.

The rules allow an individual to give up to £3,000 per tax year, exempt from inheritance tax. If an individual (e.g. a grandparent) hasn’t used their full allowance in a tax year, they can carry over the unused amount to the next tax year.

They could also make ‘gifts out of income’, and these would not be subject to inheritance tax. The payments would have to be regular and made from excess income (which wouldn’t affect the grandparent’s standard of living or need them to draw on savings). And it would be essential to keep records to demonstrate this.

Savings

If your spending is going to increase, you need to be confident your savings are working as hard as possible. With the possibility of interest rates dropping, shop around for the best rate available on all the different savings accounts. Remember, your savings need to stay ahead of inflation so that the spending power of your money isn’t reducing.

Fixed-rate cash savings accounts are likely to offer higher rates than easy-access accounts. However, there are often rules over when you can withdraw the money, which may not fit your needs.

If possible, you should also be maximising your ISA allowance of £20,000 per tax year, so you’re not paying tax on the interest.

Investing

If you can tie up your money for long periods (e.g. five to ten years), you are more likely to see better returns by investing rather than saving via cash.

That’s because your money has the opportunity to ride out the highs and lows of the stock market. But be aware that nothing is ever guaranteed, and you could get back less than you invest.

You could consider using some of your ISA allowance to invest in a Stocks and Shares ISA, meaning there’s no UK income or capital gains tax to pay on the investments in the ISA.

If you’re using this type of ISA to fund school fees, you could begin by investing for growth and switch to investments for income later. Or even sell off the investments to pay for fees. Once you have taken money out of the ISA, however, it loses its tax-wrapper status.

Trusts

Another way grandparents may consider supporting their grandchildren’s education is by setting up a trust. Assets held in a bare trust ensure the money goes to the beneficiary (i.e. the child) when they are 18.

The advantage of a bare trust is that the money is treated as if it belongs to the child, which is usually beneficial for tax purposes. But, if a parent also pays into the trust and the income on their gift(s) exceeds £100, the income tax on their gift(s) would fall to the parent.

The rules differ from a Junior ISA. So, you can withdraw money from a bare trust before your child turns 18. (Subject to the terms of the trust and if its for the benefit of the child ) This could be for school trips, sports equipment or a musical instrument.

You should also be able to use money in a bare trust for school fees, although it’s a complex area so do seek specialist advice. Tax rules can change over time and depend on your circumstances and the child’s.

If you would like some help with cashflow forecasting and financial goal setting regarding your family circumstances, please get in touch.

The value of investments can fall as well as rise and is not guaranteed.