Coming to terms with spiralling school fees: Andrew Bibby on how paying years in advance can cut costs and offer significant tax benefits

PARENTS who have decided to educate their children privately can put money aside for future school fees and receive what is, in effect, a tax-free return on their investment in the meantime, thanks to a curious feature of the charity laws.

Many private schools are only too happy to take money in advance from parents, compensating them by charging less when the fees are finally payable. The notional return parents receive from this arrangement is not subject to tax, and for higher-rate taxpayers can be equivalent to a gross return of 9-10 per cent.

Malvern College, for example, is offering a return of 5.5 per cent to parents who use its 'fees in advance' scheme, equivalent to more than 9 per cent for a 40 per cent taxpayer.

As Michael Eglington, the bursar, explained, the fees for each of the 15 terms that a child is normally in the school are reduced by a set amount, depending on how far in advance the pre-payment has been made. A lump sum of about pounds 1,050 paid four years before a child's entry to the school would means pounds 100 off each term's bill (currently pounds 3,800 for boarders).

Schemes like this are possible because most private schools are registered as educational charities and, as such, receive interest on investments tax-free. While their trustees have a duty to use the funds for charitable aims, parents also benefit indirectly.

'It's good for parents - there are the tax advantages, and they also get peace of mind,' said John Hilton, assistant bursar at Roedean, the exclusive girls' school where fees are pounds 3,995 a term. He says that the school does not normally accept pre- payments of less than six terms' fees. 'The return currently is approximately 4 per cent. The difficulty at the moment is that interest rates are so low,' he said.

Parents thinking of Eton College (fees pounds 3,978 a term) may no longer have to register their son at birth (the school changed its entry procedures recently), but Eton remains happy to take early advance payments under its pre-paid fees scheme. 'For a boy who is not yet one, pounds 800 paid now would mean that we would reduce the school bills by pounds 100 for each of the 15 terms. In other words, for pounds 800 you would get a total of pounds 1,500. Obviously, for older boys you'd have to pay rather more to get this. The current rate of return is 4.5 per cent,' said Andrew Wynn, school bursar.

He added that higher-rate taxpayers may find this long-term fixed rate, equivalent to 7.5 per cent gross, quite attractive.

Whether private schools should be allowed the substantial advantages of charitable status is politically controversial, but the knock-on advantage to parents has received rather less attention.

The Inland Revenue confirmed this week that it approves of arrangements such as these, sometimes called 'fee composition' schemes. Interestingly, there is no Revenue restriction on the size of the benefits paid to parents (although in theory a school that was excessively generous with its rate of return could attract Charity Commission interest).

A Revenue spokeswoman commented: 'It's good value for schools, because they get money up-front, and it's good value for parents because the school fees may be somewhat less. Of course, it all depends on the Charity Commission giving the school charitable status.'

Schools that operate advance payment schemes are unlikely to guarantee places for children.

However a long-established informal arrangement between most private schools means that, where a child fails the entrance test or where its parents later change their minds, the appropriate money is passed across, term by term, to the school where the child is being educated.

There are alternatives for parents who choose not to give their money to a particular school. For example, School Fees Insurance Agency, a firm of independent financial advisers in Maidenhead, set up its own associated SFIA Educational Trust in 1959. Advance school fees paid to this trust (registered as an educational charity) attract tax-free returns. SFIA says that pounds 20,000 invested now could save pounds 7,161 in school fees for a child starting school in 1997, an approximate yield of 5.4 per cent.

Details of other financial advisers offering similar school fee schemes are given on a factsheet from the Independent Schools Information Service (071-630 8793).

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