LETTING & ESTATE AGENT

School & University Fees – How a Pension Fund Could Help

School & University Fees – How a Pension Fund Could Help

Key points

·      Paying education fees reduces the ability to fund for pensions.

·      There are strategies to pay for education fees and fund a pension scheme using the same money,at reduced costs.

 

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

HMRC

Plus tax savings

20% - basic rate

£32,010

No tax effect

Adds  20% of gross  contribution to the pension fund

0

40% - higher rate

+£32,010

Expands the basic rate band by the amount of the contribution so that tax is paid at 20%

As above

20%

45% - additional rate

+£150,000

As above

As above

25%

Personal allowance of £9,440+

Lost progressively with earnings over £100,000 - £118,880

Can restore personal allowance (and expand basic rate band)

As above

60%+

 

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.

 

Example – Funding school fees

 

John earns £100,000pa, is age 40 now and takes out a loan, with interest payments at 4%, for £100,000, repayable in 15 years’ time, to cover school fees.  If he had paid the school fees out of after-tax income, the marginal cost would be 35.6%, after tax.  (He has to pay £25,000 a year for the next 4 years in school fees, and does not have a pension fund).  The cost from after-tax income is £33,900pa, which totals £135,600).

 

Pension fund required in 15 years’ time:£400,000

25% tax free cash£100,000

Monthly contribution£1,505 per month gross

(invested at 5% pa compound for 15 years)

Contribution made net (as HMRC adds 20%)£1,204 per month net

Plus 20% tax savings£301 per month

Total cost£903 per month

+ monthly mortgage loan payment at 4%£333 per month

 

Benefits

·      Pension Fund after tax free cash:       £300,000

·      School fees  and loan paid     £100,000

·      Significant easing of cash flow

·      More net disposable income available

·      Tax savings of up to 40%

·      If John earned more than £100,000, pension contributions can save his personal allowance

 

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.  

 

Tony Granger