Planning is the key in paying for a private education for your child

MANY parents would like to give their children a private education but are unsure how to best fund such a decision. Increasingly, too, grandparents wish to help with such costs, aware that money expended now could escape inheritance tax demands.

The secret is to plan ahead, starting as early as possible after a child is born. The total cost may be frightening. Funding 13 years at a day school and allowing for above-inflation fee increases, could cost 178,000 for a child aged six months now, plus probably 1,000 annually for extras such as uniform and school trips, making a total of 192,000.

John Mortimer, from the Edinburgh-based Muirfield Partnership, says that the average school fee has risen 75 per cent in the last decade, well above inflation, which has grown 20 per cent. He suggests saving regularly from income, using the ISA allowance which rises from 7,200 per annum to 10,200 in April.

The 7IM Moderately Cautious fund is tipped by Mortimer. This is a fund of funds spread across a wide array of asset classes, formed by seven investment managers in 2001. For a lower-cost alternative, try their "passive" AAP fund which uses both trackers and exchange-traded funds to achieve investment growth.

Offshore funds are great for school fee planning, says Scott Mackintosh from Edinburgh Investment Consultants, adding the proviso, "providing clients have sufficient monies to invest at the outset". The income generated can fund the fees. As such income can be assigned to children, it can be an extremely tax-efficient approach.

Most major insurance companies offer such bonds, says Grant Walker, director of Edinburgh Risk Management. Even though the grandparent is paying, the grandchild can be named as a potential beneficiary within a trust created for the purpose.

The trustees can encash the bond as required. Chargeable gains on encashment will be assessed on the child but providing the gain is less than the available personal allowance, no tax is payable. If attracted to this approach, it's vital to consult an independent financial adviser with experience in this area to ensure the bond is set up correctly.

Another option Mackintosh uses is the "umbrella" product offered by the Children's Mutual, a leading friendly society. This can accept both an adult's ISA money and annual tax-exempt friendly society allowance.

"There can be as many 'donors' as you like, meaning that if anyone is not fully utilising their personal tax-free allowance each year, it can be applied on behalf of a plan for children," says Mackintosh.

Don't fall into the trap of thinking that a Child Trust Fund can be used – access is denied until the child's 18th birthday.

Alex MacLean, of Aspire Wealth Management in Edinburgh, says three factors should be considered when planning for school fees: flexibility, cost and tax efficiency. Unit trusts, open-ended investment companies (OEICS) and investment trusts provide an effective way to build capital growth with the flexibility of making contributions regularly or an ad-hoc basis. This contrasts with the former popular method of buying a series of endowment policies, one of which matures each year.

"Removing the additional cost of life cover – a necessary part of a qualifying endowment policy – and you see the case for unit trusts is strong," says MacLean.

When the ability to use annual Capital Gains Tax exemptions to access capital is added, this method ticks most boxes.

Over such a long period of investing, MacLean says it may be prudent to save through actively-managed funds, like Jupiter Merlin Growth fund of funds. For the risk averse, look instead at Margetts Providence fund of funds, giving exposure to bonds, fixed-interest, equity income funds and cash.

If school fees need to be paid within five years, a tax-free, easy-access cash ISA is an excellent wrapper, says Walker. The money will not be subject to the potential volatility of other investments.

However, when looking further forward, Walker opts for investment ISAs, with the proviso to move into less volatile funds as the time approaches to cash in.