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
