More grandparents are lending a hand because private school fees have skyrocketed due to the government's VAT policy, but what are the tax ramifications?
Sixty-five percent of families receive assistance with paying private school fees, according to think tank Civitas. Thirteen percent of this group has received a loan from a loved one, and thirty percent has received a gift from family or friends.
When you take the price into account, it is no surprise. A day school's average termly fee in January 2025 was £7,382, up 23% from the previous year, according to data from the Independent Schools Council (ISC).
When the government's new VAT policy went into effect at the beginning of the year, costs skyrocketed, pushing even more families to use the Bank of Grandma and Grandad. The policy is causing an additional 7% of parents to seek assistance from their own parents or other family members and friends, according to data from wealth manager Saltus.
Although wealthy family members might wish to contribute by donating a portion of their fortune while they are still alive, this is not always an easy fix. Inheritance tax consequences may arise based on the method used to pay the school fees.
How is the inheritance tax calculated?
Although the laws governing inheritance taxes are complicated, the main idea is that, if you leave the family home to direct descendants, you can pass on an estate worth £325,000 before taxes are due, with an extra £175,000 allowed in certain situations.
After this, the majority of assets are liable to 40 percent inheritance tax.
Strict regulations on gift-giving have been put in place by the government to stop people from merely giving away their wealth while they are still alive. Giving away as much of your wealth as you like while you are still alive will result in a tax bill if you do not outlive the gift by seven years.
Grandparents' school fees are frequently regarded as gifts for inheritance tax purposes, so if they pass away unexpectedly, you might be hit with a high bill. Because there are ways to manage this liability, it is worthwhile to familiarize yourself with the regulations.
The exception is gifts that are not typically purchased.
Up to 3,000 of one's assets may be donated to family members each tax year without incurring IHT. You can combine the allowance and pass on 6,000 if you didn't use it the previous year.
Additionally, you can give away any extra regular income without worrying about a future inheritance tax bill. No matter how big the amount, gifts made from surplus income are exempt from inheritance tax.
In order to be eligible, the giver must demonstrate that the gift was made with income rather than capital. Furthermore, the gift cannot lower the giver's standard of living. This is most likely your best option if you're a grandparent trying to assist with the cost of private school.
You can completely eliminate the risk of inheritance tax by paying the fees on a regular basis (for instance, from your pension income), as long as you can demonstrate that the funds were used for legitimate expenses.
In contrast, the funds would be considered to have come from capital if you took money out of your savings account to pay the fees in full. It would therefore be regarded as a "potentially-exempt transfer," which means that in order to avoid inheritance tax, you would have to outlive the gift by seven years (assuming the remainder of your estate exceeds the 325,000 tax-free allowance).
Paying for school fees with your pension?
After changes were announced in the previous year's Autumn Budget, unutilized pension pots will no longer be subject to inheritance tax as of April 2027. As a result, some savers have decided to donate a larger portion of their wealth during their lifetime. One way to do this would be to pay school fees.
The potential for double taxation for beneficiaries who inherit a pension makes the tax changes on pensions significant. They will now be required to pay inheritance tax in addition to income tax on any withdrawals (charged at their marginal rate). This can lead to an effective tax rate of 52 percent for basic-rate taxpayers, 64 percent for higher-rate taxpayers, and 67 percent for additional-rate taxpayers, as we describe in a different article.
Katie Ridlands, senior partner at St Jamess Place, stated, "If we take money from the pension and pay tax on it, that is seen as earned income." This was one of the things that we were beginning to look at and were discussing with grandparents regarding school fees.
As a result, anything they are depositing now (which they may have designated as an inheritance for the following generation) can be given as a gift out of regular expenses if their other sources of income are sufficient to cover their expenses.
"The good news is that the recipients don't have to be the same or get the same amount each year as long as the gifting amount is comparable. It is changeable. If you have multiple grandchildren at varying educational stages, you can allocate the funds appropriately.
Keep thorough records as proof if you are giving gifts using money you would normally spend. This information will be required by your estate's administrators or executors when they fill out HMRC's IHT403 form as part of the inheritance tax procedure.
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