Saving for school fees

Reproduced from Professional Adviser, 26 August 2004 – interest rates quoted were current for Issues on sale at the time of publication and are no longer on sale.

• Tax 
• Downside for IFAs on regular sums 
• Priorities 
• University
• Still a place for cash 
• Child Trust Fund

Parents have never been under so much pressure to provide for the long-term future of their children, but IFAs are finding them increasingly cautious, as Sally Mantell and Jonathan Akerman of National Savings and Investments write.

The days when parents put money by for driving lessons, first cars and weddings have long gone, as they battle with the escalating costs of education.

Unless they can get their children into a good state school, even those on middle incomes appear prepared to put them through private school. At the same time, they are gearing up for the cost of university.

The current cost of a three-year degree including living costs is estimated to be £22,569 by the National Union of Students and will be forced up yet higher when top-up tuition fees are introduced in 2006 for the new intake.

With education costs rising above inflation, the consensus remains that investing in the stock market could be the only way for parents to stay on top, regardless of the level of income they may have to put by.

But the three-year stock market slide, the flat outlook and mis-selling scandals mean the level of caution shown by parents and grandparents is unprecedented, say financial advisers.

“They are asking far more questions and are a lot more concerned about risk versus reward. They want less exposure to shares, more diversity and steady growth that’s tax efficient,” says Stephen Brady of IFA Chartwell.

Dan Kemp of Douglas Deakin Young too has noticed a shift. “I would not let them invest in anything they felt uncomfortable with but equally their views have to be challenged. They tend to become cautious or adventurous at completely the wrong time.”

Some IFAs have doubled the traditional minimum five-year time frame for investing in shares for cautious investors. Unless parents are investing for more than 10 years, they offer some exposure to shares but heavily weighted with cash, fixed interest and commercial property.

“For a long period of 16-18 years, you would expect to start with a large proportion of money invested in unit trusts and investment trusts and switch it into lower risk assets as the period before the money is needed shortens,” says Patrick Connolly of John Scott & Partners.

“But some advisers go wrong by not monitoring the investments long-term once they are up and running.”

Tax

It’s easy to forget that if you’re investing in the child’s name, any income generated over £100 a year is taxed on the parents,” says Douglas Deakin Young’s Dan Kemp. “But, if the money comes from other relatives, the child’s income tax and capital gains allowance can be used. This means it is better for any gifts from grandparents, for example, to be given direct to the child rather than through the parents.”

One way to minimise the problem is for IFAs to choose growth rather than income funds and the use of discretionary trusts. Although Isas also provide tax-free returns, many advisers prefer parents and grandparents to use their allowance for their own long-term needs.

“The key thing for advisers is to establish the investment objective of parents and look at the most tax efficient way it can be achieved,” says Chartwell’s Stephen Brady.

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Downside for IFAs on regular sums

Unless parents and grandparents have lump sums to invest, commission-based IFAs can face a conflict of interest on monthly premiums. “They too need to take a long-term view which can be difficult,” says one fee-based adviser. “While some other savings plans may generate reasonable commission, the charges are high and it can be inflexible and a poor choice of investment. In contrast, an investment trust savings plan pays no commission and a unit trust savings plan only 3%.”

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Priorities

Getting priorities and timescales right for clients is always difficult, but parents who have limited money to invest who want to educate their children privately are better off focusing only on school fees, suggests Dan Kemp.

“I take a harsh view. Children can be self-funding when they go to university and it is possible for them to scrape a deposit together for a first property. It is the things they can’t pay for that are the most important.”

As school fees are more expensive for older children, it is important to look ahead to the most expensive years of GCSE and ‘A’ Levels. “It is better if they can be paid in the early years out of income but it can be tempting to dip into savings as soon as school fees start to creep up before an investment has had time to grow.”

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University

IFAs are unanimous that “education is now everything for parents”. “We’ve seen a big rise in parents who want to save for university – rather than school fees. They don’t want them graduating with big debts,” says Stephen Brady. “They know they can have a decent stab at covering the entire amount.”

Parents with a new-born baby would now need to save around £112 a month or a £13,167 lump sum to cover the total expected cost of a three-year university course starting in 18 years, (£47,631)

Parents with a child of 10 who have not started to save would need to save £187 a month or invest a £16,531 lump sum.

Source: Bates Investment Services

Assumes growth of 7% a year and education costs rising by 4% a year.

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Still a place for cash

As well as cautious savers seeking refuge in cash, parents saving for the long-term have been keen to increase the amount of cash they hold in their children’s portfolios.

Five interest rate rises since November means the gilt is gradually being restored to deposit accounts and a rate of 5% is easily achieved. For higher rate taxpayers in particular, many IFAs, including Paul Ilott and Patrick Connolly are currently recommending National Savings and Investments Index-Linked Savings Certificates.

The current five-year certificate, Issue 36, promises a tax-free return equal to inflation (RPI – now 3%) plus 1.25% a year, giving a payable rate of 4.25% worth 7.08% to higher rate taxpayers. This is currently unbeatable in any bank or building deposit account.  Following recent downward movements in gilt yields, these rates may change.

“Because the rate of inflation fluctuates it is impossible to predict what a client will get back,” says Paul. “But they do promise a real rate of return, which means that for parents with a child due to start a degree in five years, putting £15,000 maximum into this Issue would go a long way towards funding the first two university years.”

Parents who want the absolute security NS&I offers but a guaranteed rate can opt for the current five-year fixed rate certificate, Issue 78, paying 3.45% tax free. This is equivalent to 5.75% for a higher rate taxpayer and 4.31% for basic rate taxpayers.

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Child Trust Fund

On the horizon is the Child Trust Fund, which promises £250 for all children born after 31 August 2002, which will be invested in a cash or share-based account until the child is 18.

The vouchers will be issued from the New Year, although the products will not be available until April. The scheme is intended to encourage parents to save for their children’s future and up to £1,200 a year can be contributed.

However, IFAs recommend that the Child Trust Fund should not be considered in isolation as a way of financing a child’s future.  As one adviser suggests, “The amount of money involved won’t make it efficient unless you are including it in holistic financial planning for a fee.”

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