Paying school fees – reduced pension fund
The average costs of funding a private education and paying school fees will be about £250,000 and university fees a further £60,000 for a three year degree course (i.e. accommodation and living costs plus tuition fees) in today’s terms. Paying for education fees can be more than you will pay for your mortgage, and leave you with a reduced pension.
Paying from after-tax income
Those who have not saved for school fees pay from after tax income, in the main. For a 40% taxpayer, to pay school fees of £15,000 requires pre-tax earnings of £25,000.
Using loans and repaying from pension fund tax-free cash
With a tax rate of (say) 40% and re-mortgage borrowing costs at (say) 3-4%, many will take out loans and use home equity to fund school fees. A useful strategy would be to increase pension contributions to create a larger pension fund, from pre-tax earnings. From age 55, the tax-free cash available from the pension fund can repay the loans taken earlier. This strategy also reduces the cost of school fees, and targets increased pension funding.
Tax treatment of personal pension fund contributions
Marginal rate of tax
Taxable earnings 2013-14
Action of pension contribution
Plus tax savings
20% - basic rate
No tax effect
Adds 20% of gross contribution to the pension fund
40% - higher rate
Expands the basic rate band by the amount of the contribution so that tax is paid at 20%
45% - additional rate
Personal allowance of £9,440+
Lost progressively with earnings over £100,000 - £118,880
Can restore personal allowance (and expand basic rate band)
In the 2013-14 tax year, the maximum annual pension contribution allowance is £50,000, and this drops to £40,000 in 2014-15. You are also limited to 100% of salary or taxable income, with a maximum of £50,000.
Practical Tip :
1.HMRC can pay your school fees bill if you take out a pension plan. You can borrow money at cheap rates now to cover the school fees, and repay the loan from pension fund tax-free cash from age 55.
2.With pension contribution carry forward rules, up to £200,000 can be contributed in this tax year.
In the example above, the HMRC effectively pays your school fees bill, through its contributions and tax savings. However, as always with pensions and other investments, you should seek independent financial advice in advance.