Plan ahead to manage the rising costs of education

With the abolition of the popular Child Trust Fund (CTF) scheme earlier this year, parents and providers have been left with limited options to saving for their children in a tax-efficient way.

As popular as CTFs were, they always looked vulnerable as soon as Chancellor George Osborne began to introduce measures to save £6.2 billion in the 2010-11 financial year.

Half a year since the abolition of CTFs, and the Government announced the introduction of a new tax-free savings account for children, labelled the Junior ISA.

The new accounts, which will be available from autumn 2011, will be set up so that funds placed into the account will be owned by the child and are locked in until the child reaches adulthood. There will be cash or equity options and annual contributions will be capped.

Crucially, unlike the CTF, there will be no government contributions into the account, although all gains will be tax-free.

Eligibility for the new Junior ISA will be backdated so that children born between the introduction of the new accounts and the closure of the CTF programme will not miss out.

At the launch of the new scheme, Mark Hoban, financial secretary to the Treasury, said that the constraints on public finances meant that CTFs were never going to be sustainable, but the Junior ISA will at least be a well-received alternative.

He explains: “Following an informal consultation with a range of stakeholders, it is clear that there is an appetite for families to have a clear, simple and tax-free savings option for their children following the end of CTF eligibility from January 2011.”

Naturally, the industry has started research into the types of products they could prepare by the autumn 2011 deadline, but the general opinion is that there will be just as much choice on offer as there was before the changes, if not more.

JPMorgan is among the providers that have gone on the record to embrace the new changes.

James Saunders-Watson, head of investment trust marketing at JP Morgan says the introduction of junior ISAs are likely to be embraced by a great many investment organisations with vastly different propositions, including investment trust ISAs.

He notes: “The move to provide a more simple and straightforward way for parents to save for their children’s future will hopefully prompt more people to realise the benefits of using investment trust ISAs as an effective investment vehicle for their money.

“We believe that the core holdings within a portfolio are important as they provide the foundations of a great investment portfolio and it is important to review these holdings to ensure they are still relevant for your needs as your child grows up.”

Lloyds Banking Group is also among the many providers preparing for the launch of junior ISAs, following its recent marketing activity for its Halifax-branded ISA products with its ‘ISA promise’.

The company already offers a children’s savings account paying 6 per cent interest and has been involved in the discussion stage of a number of government initiatives to encourage saving from a young age.

Russell Galley, managing director of savings at Lloyds Banking Group, says, “We have long been a champion of both ISAs as a form of savings and of children’s accounts in particular. The combination of these two in the new Junior ISA is a very positive step towards helping parents teach their children the value of building a nest egg for the future.”

Saving for education

The recent protests about the proposed increase in tuition fees to £9,000 a year have illustrated the mass of public opinion about the changes.

Of course, if this coalition policy gains royal assent it will mean that parents are going to have to give further consideration to their future financial position if they want their offspring to continue on into higher education.

Kate Moore, head of savings and investments at Family Investments warns that any increase in tuition fees will mean that many young people will face a very difficult decision about the affordability of higher education without parental savings.

She says: “In the US where university fees can run into tens of thousands of dollars a year, parents begin saving for their children’s college fund at a very young age.

“In the UK, this move to increase tuition fees is likely to catch many parents unaware as this college savings habit has not been established. With the abolition of the Child Trust Fund and now the introduction of £9,000 annual fees, it is more important than ever that the Government quickly announces its plans for a tax efficient replacement product so that new parents can make provision for the higher cost of university.

“It’s not just fees which are on the increase, the monthly cost of living for a full time student has increased from £561 in 2004 to £718 today. If the cost of living continues to rise at the pace seen in recent years, students may need to find as much as £818 a month just to meet their basic living costs by 2013.”

The latest figures from a poll conducted by M&S Money made for staggering reading. Training costs for children to qualify for their chosen careers now stand at £24,686 for boys or £31,049 for girls, according to the research.

The financial services brand of Marks & Spencer found that the most expensive career to pursue was training to be a pilot – costing £105,000, or acting, which, quite incredibly, now stands at £78,828.

These costs include actual tuition fees and the cost of accommodation rather than the cost of living while studying as well as necessary costs in finding a job in the profession. The current average university degree costs were used to calculate the figures.

Around 1,700 children between the ages of eight and 13 were interviewed to identify which careers they are most likely to pursue.

The majority of children see themselves in service-orientated professions, although fame and fortune do still apply to some, with 14 per cent of boys aspiring to be a footballer and 7 per cent of girls wanting to be an actress or a dancer. More creative careers also appealed to youngsters, with 5 per cent of boys looking to design computer games and 3 per cent of girls wanting to be an artist or become an author.

As this research shows, any higher education course – traditional or contemporary is going to rise and there is a very real risk that cost will become a barrier to these children achieving their goals if savings aren’t considered from an early age.

With that in mind, the following guide should provide food for thought for any parent looking to support their child in the vital years of education.

CTF alternatives

As parents look for alternatives to CTFs and while the new arrangements haven’t been confirmed, the popularity of bare trust arrangements – or simple trusts have come back in vogue.

Bare trusts are where a third party has an immediate and absolute right to the capital and income from the trust, making them ideal for passing on assets or money to children from parents or grandparents.

The difficulty for many investment houses are that these arrangements can be difficult to administer, and that has led to a number of wealth management companies deciding against offering them.

Among those companies refusing to offer bare trust arrangements at present are JP Morgan and Invesco Perpetual. While both companies offer children’s funds – where a third party can invest on behalf of a child – this is simply through a designated name account.

HM Revenue and Customs rules dictate that once established, the name in which the trust has been established cannot be changed. The assets are held in the name of the trustee, who manages and makes decisions about the funds under management. In Scotland, a child can access these funds at the age of 16 while the age is 18 in England and Wales.

But beware, there are limits on how much can be put into a bare trust without attracting additional taxes. For example, if a trust returns more than £100 gross income a year, then it will be taxed as the parent’s income.

The child will not be able to claim back tax on the income and interest will not accrue without a tax deduction. The trustee is permitted to receive income from investments such as dividend or rental income or even bank interest, but the child will be liable for tax on income received by the trust.

In addition, a trust may also have to pay capital gains tax if assets are sold, given away or disposed of should they increase in value in excess of the annual exemption limit.

For those parents who would like a little more control over the money invested for their children, a discretionary trust may be more appealing. In a discretionary trust, trustees have control over how to use the income and how the capital is distributed – particularly useful if not all of the money is to be handed over in one lump sum.

Take note, however, that these arrangements are subject to much higher tax penalties with trustees responsible for declaring and paying income tax on the trust each year. Income is taxed at higher rates for everything after the first £1,000.

For the 2010-11 tax year, trust income up to £1,000 is charged at a basic rate of 20 per cent on rent, savings and trading activities, while UK dividends pay the standard 10 per cent rate. Over the £1,000 mark, the higher rate of 42.5 per cent is charged on dividend income with other income taxed at the top 50 per cent rate.

If parents or grandparents are unsure of the best vehicle for their savings, it is always best to consult a financial or specialist tax adviser.

Child pensions arrangements

Less popular long-term savings alternatives for children are self invested personal pensions (SIPP), which cannot be accessed by the beneficiary until the legal retirement age but provide significant tax advantages.

There is no lower age limit at which time a legal guardian can start a SIPP for a minor, which is likely to appeal to parents and grandparents looking for a long-term savings plan.

Contributions made into a junior SIPP qualify for tax relief at £3,600 each year for the child of which £2,880 will be from parent’s or grandparent’s personal contribution. The remaining £720 is tax relief so you are essentially getting basic rate tax relief.

For example, if you were to put in £80, it will be grossed up to £100 – granting a total of 20 per cent tax relief.

Laith Khalif, pensions analyst at Bristol-based financial services group Hargreaves Lansdown says Sipps are probably not as popular as they should be, although people are increasingly waking up to the benefits following the demise of CTFs.

Investors that manage their own assets through a Sipp tax wrapper tend to be more switched on to the various options available to them, according to the pensions analyst who recalls a recent case.

He says: “We had one guy whose child was born on the 1 April and, within a couple of days he had made a Sipp contribution for her because he knew that the tax year was ending.”

Khalif says that an investor’s choice for child pensions planning essentially boils down to two options a Sipp or stakeholder account.

For those wanting a more active role in managing their investments, a Sipp could possibly be more appropriate while a Stakeholder pension might potentially be cheaper – although this is not necessarily the case.

When weighing up the best option, look more closely at the charges and not just at the range of investment options available.

Stakeholder pensions are meant to be low cost, but could cost up to 1.5 per cent a year for the first 10 years (before falling to one per cent thereafter). It is possible to find basic Sipps that charge the same with an active management option.

To discover more about saving for education, click here.