Incurring expenses on grandchildren's education triggers potential Inheritance Tax liabilities
Revamped Article:
Paying for private school fees often calls for assistance, with a staggering 65% of families seeking it - as per research by think-tank Civitas. A whopping 30% receive a gift from loved ones, and 13% receive a loan from family or friends.
Such numbers aren't surprising when you consider the soaring costs. As per the Independent Schools Council (ISC), the average termly fee for a day school reached an eye-watering £7,382 in January 2025, marking a 23% increase compared to the previous year.
The burden grew even heavier at the start of the year due to the government's new VAT policy, prompting a further 7% of parents to solicit help from their own kin.
The Perks and Perils of Family Help
While wealthy relatives might be inclined to help out by parting with some wealth during their lifetime, it's not always a straightforward solution. The method of payment may have inheritance tax implications.
Untangling Inheritance Tax Web
Inheritance tax rules can be convoluted, but the gist is simple: everyone can pass on an estate worth £325,000 tax-free, with an additional £175,000 allowance in some instances, if you leave the family home to direct descendants. Beyond these limits, assets are typically subject to a 40% tax.
To discourage people from simply giving away their wealth during their lifetime, the government has enforced stringent gift-giving rules. You can gift as much as you desire during your lifetime, but if you don't survive the gift by seven years, there will be a hefty tax bill.
In many cases, school fees paid by grandparents are classified as a gift for inheritance tax purposes, which could land you with an unwelcome bill if they were to suddenly pass away. To avoid such surprises, it's wise to familiarize yourself with the rules — as there are strategies to manage this liability.
The Exception: Gifts That Speak of Normal Spending
Anyone can give up to £3,000 of their assets to loved ones each tax year without that sum becoming liable for IHT. If you didn't use the allowance last year, you can combine it and pass on £6,000.
You can also gift surplus income without running the risk of a future inheritance tax bill. Such gifts are not subject to IHT, regardless of their size.
To qualify, the gift giver must prove that the gift originated from income, not capital. Additionally, the gift should not impact the giver's quality of life. Grandparents looking to assist with private school fees might find this their best option.
By making consistent payments that cover the fees out of your pension income, you can steer clear of IHT entirely if you can demonstrate that the money came from normal expenditure. On the other hand, if you were to drain your savings account to pay the fees in a lump sum, that money would be classified as capital, subject to a 7-year rule for inheritance tax purposes.
Pension Pots: IHT Safe Until 2027
Unused pension pots are not currently subject to IHT, but this privilege will end in April 2027 after changes announced in last year's Autumn Budget. This shift has prompted savers to transfer more of their wealth in their lifetime, making school fee payments one possible route.
The impending tax changes on pensions carry significant implications, as beneficiaries who inherit a pension may face double taxation. Not only will they pay income tax on withdrawals, but they'll also contend with IHT. As detailed in a separate article, this could translate to an effective tax rate of 52% for basic-rate taxpayers, 64% for higher-rate taxpayers, and 67% for additional-rate taxpayers.
"One of the things we're discussing — with grandparents planning school fees — is if we withdraw money from the pension and pay taxes, that income is treated as earned income," said Katie Ridlands, senior partner at St James's Place.
"Therefore, if your other income sources cover your needs, anything you're putting down at this point (which may have been intended as inheritance for future generations) can be given as gifts from normal expenditure."
The key advantage is that, so long as the gifting amount is similar each year, the beneficiaries don't have to be the same or receive the same amount every year. You can adjust the gift amounts accordingly if you have grandchildren at different stages in their education.
If you're making gifts from normal expenditure, it's important to maintain detailed records as evidence. Your executors will need this information to complete HMRC's IHT403 form during probate.
Enrichment Data:
Insight #1:
Treating pension income as part of your normal expenditure can make regular school fee payments exempt from inheritance tax, provided the payments do not impact your lifestyle and are well-documented.
Insight #2:
With tax changes coming into effect in 2027, unused pension pots will be subject to IHT. Utilizing pension income to pay school fees may become an increasingly attractive method of wealth transfer, especially as it can potentially minimize inheritance tax liabilities.
| Payment Type | Source | IHT Status | Notes ||-----------------------------|-----------------|---------------------------|---------------------------------------------|| Regular school fee payments | Pension income | Usually exempt (if surplus) | Must not affect standard of living || Lump sum gifts | Capital/Pension | Potentially liable | Subject to 7-year rule if not exempt |
- When grandparents make regular school fee payments using pension income, it could potentially exempt these transactions from inheritance tax, as long as the payments are considered normal expenditure and adequately documented.
- As tax changes approach in 2027, with pension pots becoming subject to inheritance tax, paying school fees from unused pension income might become an increasingly popular method for wealth transfer, potentially reducing inheritance tax liabilities.
