University Fees Planning – Giving them the best start!
Let’s take a look at the NISA and JISA and how you can help your children and grandchildren through this financial challenge .
In the 2014 Budget the government – in Launching the New Individual Savings Account (NISA) – announced substantial improvements to the Individual Savings Account (ISA) and renamed existing ISAs as NISAs.
Most notably with effect from 01 July 2014 –
- The maximum annual investment is now £15,000
- NISA contributions in a tax year can be invested in any proportions between the cash and stocks and shares elements.
- Stocks and shares within a NISA can be converted into cash and vice versa
- The maximum contribution to a Junior ISA (JISA) has increased to £4,000
1) THE NISA
Due to their tax freedom, NISAs are an ideal way for people to save to meet future anticipated financial needs. One such financial need, which has become increasingly more important for many investors, and which is growing daily, is that of helping a child or grandchild through university and/or getting them on the housing ladder.
Whilst Loans are available to students to help with the costs of a university education, many parents (and grandparents) would be shocked at the thought of a child starting work at age 21 with up to £60,000 of outstanding debt. But that can be the stark reality of the situation. No wonder parents are quite rightly keen to look at ways in which they can help resolve this particular problem.
A NISA, of course, is not the only way to save to meet this need. The investment(s) chosen will frequently depend on the investor’s objectives and circumstances.
- Whether the investor has a lump sum to invest or wishes to save out of income
- How much control is needed over the investments made, for example, if say the child/grandchild did not attend university
- How long is it before the funds will be needed?
In this article we focus on three areas – the financial issues a child may face, what help is available from the State and some of the financial solutions that may be appropriate.
First let’s look at the financial needs that a child may have –
2) THE FUTURE FINANCIAL NEEDS OF CHILDREN
Children are facing hardship in two potential areas –
Onerous borrowing conditions, such as deposit levels and income multiples, when combined with escalating house prices, have made it more difficult for an adult child to borrow money for house purchase. With the introduction of the Mortgage Market Review, most lenders will include (or at least should consider) student loan repayments in its suitability checks when considering whether students will be eligible for a mortgage. Indeed, things have got so bad on this front that it is now estimated that one in four 20–34 year olds still live with their parents.
Following the government’s announcement three years ago that universities can charge up to £9,000 per annum for tuition fees, there is obvious parental concern as to how this cost will be met. A significant number of English universities make a full charge for this, although some charge less. And that, of course, is not the end of the outlay because the maintenance costs incurred by the child must also be factored in
3) HOW MUCH IS NEEDED ?
It is very difficult to speculate how much a child may need help with a mortgage and when this cash will be needed. We can, however, be a bit more precise with university costs. The amount of cash needed to see a student through university can be substantial. According to research carried out by Endsleigh, the following is the estimated current average yearly cost of a student attending university:
Tuition Costs £10,133
Halls of Residence £2,980
The need therefore (in current terms) is to fund £50,208 (£16,736 per annum for three years). Let’s take a parent who wishes to advance fund for the university costs of his three-year old daughter. Factor in inflation at 2% pa and one is looking at the need to provide £67,571 for a child now aged three. Based on a growth rate of 5% pa net and ignoring tax on any encashed amounts, this would mean that a lump sum of £32,503 would need to be invested now. Alternatively, the parent could pay £254 per month.
4) STUDENT LOANS
Fortunately, there is a system of student loans in place that can assist in meeting some of these costs.
Loans for Tuition Fees
Loans to meet tuition fees are available up to £9,000 per annum (£6,000 for a private university or college), with the money paid direct to the institution. If tuition fees are being paid directly by a parent without the student taking a loan, a percentage (usually at least 50%) needs to be paid upfront before a student can register. Of course, tuition fees may not be the full £9,000. Some universities may only charge £6,000 per annum but when this is the case, there will probably be other additional educational costs – such as for books, food etc. A student loan for tuition fees is not means tested.
Loans for Maintenance Costs
Full-time (not part-time) students can apply for a maintenance loan to help them with accommodation and living costs. Maintenance loans are paid into the student’s bank account at the start of each term.
The amount that can be borrowed depends on:
• Where the student lives
• Where the student studies
• What year of study the student is in
• Whether the student receives a (non-repayable) maintenance grant
A maintenance grant is available to some students where household income is £25,000 or less and is designed to help with living costs. The current amount of maintenance loan varies between £4,418 and £7,751. However the availability of these loans does, to a degree, depend on the income of the students family, so there is no guarantee they will be available. How much is payable depends on the individual circumstances of the student and their family.
Repayment of Loans
The rules for the repayment of student loans are as follows:
• Full-time and part-time students who started their course after 1 September 2012 begin paying back their student loan once they earn more than £21,000 gross a year
• Repayments for courses that started after 1 September 2012 will not begin until April 2016, or the April after graduation whichever is the later
• If a student’s income falls below £21,000 gross a year, their repayments stop
• Part -time students earning more than £21,000 gross a year will start repaying their loan in the April four years after the start of their course. This applies even if they are still studying
• Once gross earnings exceed £21,000, 9% of the excess is automatically deducted as a loan repayment. A graduate earning £22,000 would pay £1.50 per month graduate earning £22,000 would pay £1.50 per month. For example, if a student’s course finishes in June 2015 and they get a job paying £25,000 gross in September 2015, repayments will start in April 2016. Repayments must be made monthly and are based on 9% of income over £21,000. In this case, £30 would be payable each month from April 2016 (i.e. £4,000 x 9% = £360 per annum or £30 per month)
• As far as interest is concerned, the loan will increase by RPI plus 3% while the student is studying. The longer the debt is held, the more the cost will be. After graduation, the interest rate is linked to earnings – the more money the student earns, the higher the rate will be. Those earning less than £21,000 pay interest linked to the inflation rate (so zero interest in real terms); those earning £41,000 or more will pay RPI plus 3%. Between these two amounts, graduates will pay interest on a sliding scale, which means that for every £1,000 they earn over £21,000, they will pay an extra 0.15% interest
• How long will it take to clear a student debt? Well let’s assume a student takes a student loan of £14,000 each year to cover tuition costs of £9,000 and maintenance costs of £5,000. If on leaving university they start a job with a starting salary of £40,000, on the basis of inflation of 3% pa and salary growth of 2% above RPI, the outstanding debt will still not have cleared in full in 30 years, when the remainder will be written off. However, at that point the graduate will have paid back about £133,000 which includes about £89,000 in interest – significantly more than the £42,000 they borrowed upfront to cover tuition and maintenance costs.
While the loan facility provides reassurance to university students (and their parents) as to how they will meet these costs, many parents are concerned that their children may be leaving university with a substantial debt that could take years to repay. Indeed due to the addition of interest, the outstanding debt will increase for those with higher incomes in later life. And, of course that outstanding debt may have a significant impact on another important financial issue for children – namely the desire to purchase a house.
Parents (and grandparents) will therefore be keen to give financial support to their children/ grandchildren. And the earlier they can put planning in place, the easier it will be to deal with these financial burdens in the future.
So what savings vehicle(s) should be used to fund for this? Well, this depends on whether the investor is using a programme of regular savings or is able to make a one-off payment. For parents, it will frequently be the case that regular saving is the only option. For grandparents, Lump sum investment may also be an option. We now look at these areas in turn.
5) REGULAR SAVINGS BY PARENTS
a) The JISA
- Is available for any child under age 18 who does not have a Child Trust Fund (CTF) account. To invest in a JISA, a child must therefore have been born before September 2002 or after 2 January 2011.
- Permits contributions of up to £4,000 per annum. These contributions would normally be payable by a relative such as a parent or grandparent.
- Can be invested in cash funds and/or stocks and shares.
- Provides tax freedom on capital gains and investment income (although the tax credit on dividends cannot be recovered).
Although the proceeds are not accessible until the child gets to age 18, that can fit in nicely with it being used to fund university costs as we explain below.
If the maximum £4,000 is invested in a JISA each year from a child’s birth for 18 years then, assuming growth at 5% net per annum, this will produce a tax-free fund of about £118,156 after 18 years – more than enough to cover the current cost of a three-year university degree course (which would be £73,669 assuming costs increase by 3% per annum).
The obvious benefits of the JISA are that it is tax free and that parents (and other relatives) can contribute up to a total of £4,000 each year. In the case of parental contributions, because the £100 parental settler income tax antiavoidance rule does not apply, income arising in the JISA will not be assessed on the parents and will, in effect, accrue tax free.
If there is a reasonable period before the child will attend university, equity-based investments within the JISA may be suitable. If investment performance has been good, as the child approaches 18 it may be appropriate to switch to cash-based investments to consolidate any gains.
As mentioned above, it will not be possible to open a JISA for a child who has a CTF account. Around six million children born between September 2002 and January 2011 qualify for a CTF account and cannot invest in a JISA.
The good news is that the annual contribution limit for the CTF has also increased to £4,000. In addition, it would seem likely that with effect from April 2015 it will be possible to switch a CTF into a JISA, which will allow access to the greater range of investment funds that are available for a JISA.
Only a parent or guardian can open a JISA, but anyone is allowed to pay into the account as the child grows up. The money cannot usually be accessed until the child turns 18, when they take control of the funds.
b) Cash ISAs for Children
The recent changes in the rules mean that some teenagers can now invest more than their parents into a NISA, but families must be careful not to fall foul of the tax rules.
in a quirk of the system, children aged 16 or 17 can hold both a JISA and an adult cash NISA. With the annual NISA limit increased to £15,000 and the JISA limit increased slightly to £4.000, children aged 16 will be able to save up to a potential £38,000 over two years. At age 18, the child will only be able to invest up to £15,000 a year into a NISA.
This could be attractive for parents or grandparents Looking to put money aside for their children’s or grandchildren’s university education, or to help with house purchase, who can use these investments to build up assets for their children or grandchildren. However, parents considering funding the increased cash NISA allowance for their child will have to be careful. If money given to a child by a parent to invest in a cash NISA generates more than £100 a year in interest. the income will be taxed on the parent because of the £100 income tax anti-avoidance rule. This rule exists to stop parents putting money into their children’s names to avoid paying tax.
The £100 Limit applies to each parent’s gift. So, if each parent gifted £7,500 to fund a cash NISA, or £15,000 in total, and the annual interest was £190, this would work out as £95 of interest on each parent’s gift – just within the limit. Also, the £100 rule cap does not apply to money given by friends and other family members, for example grandparents.
As we noted above, a JISA is specifically excluded from the £100 rule and this is a key advantage over a standard child savings account.
Once the child turns 18, their JISA automatically converts into an adult NISA and they will then be able to contribute the full adult annual subscription of £15,000 (or whatever the allowance is at the time).
The downside is that there is no control over the child’s ability to access the fund at age 18 and, of course, they may not then want to go to university.
Parents who are concerned about this point could consider investing in their own name until the child attends university. Appropriate investments here for parents investing out of income could be the usual NISA (see C below), a qualifying life policy (see D below), and growth collectives (see E below)-
c) Parental NISA
Here it is contemplated that the parent would affect the NISA in their own name and therefore keep complete control over when the NISA is encashed.
For a taxpaying investor, it is still undoubtedly the case that the NISA remains the main method of investing savings with freedom from income tax and capital gains tax (CGT) without giving up the flexibility of access to the investments.
As stated above, the NISA has undergone an overhaul. Now, up to £15,000 can be invested in a tax year and this can be split in any proportion between the cash and stocks and shares elements. Also, there is now no restriction on switching funds out of stocks and shares into cash inside a NISA wrapper. Life styling strategies can therefore be incorporated and this could be important in the run up to a child’s 18th birthday, when the funds that are invested are earmarked for help with meeting the costs of a university education.
The increase in NISA limits means a couple could between them invest £30,000 each year into this tax-free environment – that’s £300,000 over 10 years.
Of course, no tax relief applies on the payments into a NISA but income and capital gains are free of tax. The tax credit on a dividend is not recoverable so, for the basic rate taxpayer, a NISA invested in equities gives no income tax advantage. However, for a 40% taxpayer, tax freedom means the net dividend income yield improves by 33.3% and for a 45% taxpayer by 43.9 %.
The tax efficiency of a NISA is that investments have scope to increase in value at a faster pace. The earlier a programme of NISA savings is established, the better. Of course, because here we are looking at a NISA in the name of the parent or grandparent, they will automatically be able to exercise control over the timing of any encashment of the NISA and the application of the NISA proceeds. This means that, should the child or grandchild go to university at age 18, the funds can be accessed as required. If the child/grandchild does not go to university the funds can remain invested – perhaps to help with future mortgage costs of the child/grandchild or with future retirement provision for the parent/grandparent.
d) Qualifying Savings Policies
The ability to shelter savings within the tax- free shelter of a qualifying policy was severely dented by the Finance Act 2012. With effect from 6 April 2013, no more than £3,600 per annum in total can be paid into policies effected after 21 March 2013 if complete tax freedom is required. This applies equally to premiums paid to Friendly Society Plans. Despite the annual limits, it is still possible to invest £36,000 in total (£72,000 per couple) for 10 years and, particularly for a higher rate taxpayer, this could form a useful contribution towards the costs of a child’s university education.
The main tax attraction of a qualifying savings life policy is that the proceeds at maturity are completely tax free, irrespective of amounts. It may also be possible to take benefits as regular tax-free payments.However, the funds are not easily accessible before the expiry of 10 years and, given the recent restrictions that have been imposed, there are now even fewer providers of these plans.
The plans can be systematically encashed for several years to provide a stream of tax-free income. This can be achieved by establishing the plans as a number of individual policies (known as segments) and encashing whole policies each year. Alternatively, if the policy permits, it may be possible to engineer regular tax-free ‘income’ by using full premium recycling each year. Either way, a stream of tax-free capital sums can be generated, which could be used to meet university costs.
The plans can be written under a revert to settlor trust so that the benefits payable on death within the first 10 years are free of inheritance tax (IHT), yet the settler can benefit at maturity of the plan. Should the investor (ie the life assured) die, the policy proceeds will be paid out under trust to their family but should they survive to the selected maturity date, they will be entitled to the policy proceeds. Because the gifted benefits would be carved out under the trust, this could be achieved without the IHT gift with reservation and income tax pre-owned assets tax provisions applying.
e) Growth – Oriented Unit Trusts/OIECS (Collectives)
Given the relatively high current rates of income tax as compared to the current rates of CGT, it can make tax sense to invest for capital growth as opposed to income. This is particularly the case for the higher/ additional rate taxpayer. Parents who wish to make regular payments out of income could therefore contribute to a unit trust/ OEIC geared to capital growth with a view to building up a fund that could be accessed in a tax-efficient way as and when needed.
Although income (dividends and interest) on collectives is taxable – even if accumulated – if this can be limited then so can any income tax charge on the investment. Instead, if emphasis is put on investing for capital growth, not only will there be no tax on gains accrued or realised by the fund managers, it should also be possible to make use of the investor’s annual CGT exemption (currently £11,000) on encashments. This would enable the investor to enjoy a stream of tax-free capital payments that can be used to meet the university costs of a child. Gains in excess of the annual exemption only suffer CGT at 18% and/or 28% currently (depending on the investor’s income tax position).
For couples, it makes sense for each of them to invest in order to be able to use both of their annual CGT exemptions when investments are encashed.
Of course, as for all financial planning, a careful balance needs to be struck between investment appropriateness and tax effectiveness. While investment performance through capital growth is obviously tax attractive, reliance on growth at the expense of income can introduce (possibly unacceptable) risk.
Bob is 67. He has high expectations for his grandson, Charlie, who is nine-years old but realises that under the current rules he may well need some help in getting through university. To this effect, Bob invests £30,000 into an offshore bond, which is set up as 30 segments/policies. Because he cannot be certain that Charlie will go to university, he effects the bond on an own life/own benefit basis.
After 10 years the bond has grown In value to £75,000. Charlie goes to Durham University and needs help with university costs.
Bob therefore turns to his offshore bond. In the first year of attendance at university he assigns 10 segments to Charlie, which are worth £25,000. No chargeable event occurs and the transfer is a PET for IHT. Charlie encashes the segments and realises a gain of £15,000. The gain is covered fully by his personal allowance (£10,500) and nil rate savings band (£5,000) in 2015/2016 terms. The exercise is repeated for the next two years to give Charlie a tax-free stream of income to help with university costs.
6) LUMP SUM INVESTMENTS BY GRANDPARENTS
For those who may need to provide help with funding the costs of university in the shorter term, it may be worth asking grandparents for assistance. Frequently, grandparents will have capital available that they do not immediately need and they may be prepared to invest on behalf of a grandchild who aspires to a university education. Also, grandparents are not subject to the income tax anti-avoidance rules that apply to parents.
Clearly, any investment should be made in such a way as to achieve maximum tax efficiency. The approach to take will depend on whether the grandparent wishes to keep possible personal access to the investment before the child goes to university or whether the grandparent is happy to give up access.
a) Grandparents Keep Complete Control
In cases where the grandparent wishes to keep complete control over the investment until the grandchild does indeed go to university it may be worth considering an investment in an offshore bond. In these circumstances, to secure the maximum tax efficiency on the investment, the grandparent could consider investing in an offshore single premium investment bond written on a joint lives last survivor basis. Full access to and control over the bond would remain with the grandparent. The main tax benefit of the offshore bond is gross roll up on the underlying investment funds.
When the child reaches age 18, the decision could then be made as to whether the benefits of the bond should be made available to the child. If the child then goes to university, the grandparent could at that time assign sufficient segments to the child for him or her to encash and use the proceeds to meet the first year’s university costs. A similar process could be adopted and used in years two and three.
The transfer (by way of assignment) of the segments from the grandparent to the grandchild would not give rise to a chargeable event so no income tax charge will arise at that time. On subsequent encashment by the grandchild, hopefully any chargeable event gains could be absorbed (or substantially absorbed) by his or her personal income tax allowance and so be tax free.
The personal allowance is £10,000 in 2014/2015 and scheduled to increase to £10,500 in 2015/2016. In addition, because chargeable event gains under offshore bonds are categorised as ‘savings income’, they will be subject to the savings rate tax rate if they exceed the child’s personal allowance. For 2015/2016 the savings rate will be at 0% and the band will be £5,000. A child with no other income could therefore, in theory, enjoy a chargeable event gain of £15,500 under an offshore bond with no tax charge (see example ‘Bob’ above). The assignment of the segments within the bond to the child would, of course, be a potentially exempt transfer (PET) for IHT purposes.
An alternative, especially if the investor envisages being able to use their annual CGT exemptions, would be to invest in collectives and encash them when the grandchild goes to university. The cash proceeds could then be gifted to the grandchild. Provided the annual exemption is available when the encashment is made, any CGT may be avoided or minimised.
b) Grandparent Prepared to give up Personal Access and the Use of Trusts
Provided the grandparent is prepared to give up personal access to the investments, a trust arrangement could be considered. The approach to take will probably depend on the grandparent’s view on, firstly, the likelihood of their grandchild going to university and, secondly, the degree of maturity the grandchild is likely to show at that time.
In cases where the grandparent is confident the grandchild will have a mature disposition at age 18, a bare trust-based investment will offer maximum tax efficiency. Where more control is required over the investment so that there is, in effect, a ‘wait and see’ approach before the grandchild benefits at age 18, a discretionary trust may be more appropriate. We will now look at each of these in more detail.
Here the grandparents could consider an investment into a collective investment held subject to a bare trust for the absolute benefit of the grandchild.
The advantages of this structure would be:
- Income will be taxed as the grandchild’s (but recovery of the tax credit on dividends will not be possible)
- Capital gains will be taxed on the grandchild so this is an ideal way of using the grandchild’s annual £11,000 CGT exemption
The grandchild could draw down on the investment from age 18 and, provided capital gains fall within the annual CGT exemption, in effect enjoy a tax-free stream of capital payments.
An alternative investment would be an offshore single premium bond. Here, because the investment would be held subject to a bare trust, any chargeable event gains would be taxed on the grandchild. The £100 income tax rule would not apply because the settlor is not a parent. This would mean that it may well be possible to periodically encash segments and trigger a chargeable event gain that fell within the grandchild’s income tax personal allowance and so was tax free.
A discretionary trust would give control to the trustees to determine who should benefit in the future and, if the grandchildren do go to university at age 18 and are then responsible, the trustees could consider an appointment of benefits in their favour.
Trustees of discretionary trusts are charged to income tax as if they are additional rate taxpayers with them paying income tax at 37.5% on dividend income and 45% on all other income. Therefore, it would be best for the trustees to invest for capital growth, for example in collectives, to use their annual CGT exemption (which is normally £5,500), or at least invest in non-income producing assets such as an offshore single premium bond.
Having made an appropriate absolute appointment of capital in favour of the grandchild, all or part of the investment could be transferred into the name of a grandchild at age 18 for them to encash and provide for university costs.
In the case of an offshore single premium bond, this could be achieved by assigning segments in the bond from time to time. No income tax charge arises on an assignment of segments by the trustees to a beneficiary. In the case of a transfer of collectives, as this would trigger a disposal for CGT purposes the trustees and beneficiary could make a CGT holdover claim (assuming at that time the trust was eligible to make a claim). In both cases, an IHT exit charge may arise.
Children face a daunting financial future in terms of funding for the costs of a university education, house purchase and/or wedding. Early financial planning by parents and grandparents using financial products and, where relevant, trusts can considerably ease the problems.
The improvement to the JISA and the ISA should be regarded as a catalyst for financial advisers to discuss appropriate planning options to meet this funding need with their clients.
John Woolley of Technical Connection