Funding the Costs of a University Education just got Nisa
We have now just passed the “exam result” season. Many eighteen year olds will have bitten their nails with nervousness over their grades in the anticipation of whether they will gain entry to the university of their choice.
Many parents may equally be biting their nails wondering if they can afford to fund their children going to the university of their choice.
The costs of a university education can be enormous – £57,000 is not an unreasonable estimate when one adds the maintenance/daily living costs of, say, £10,000 per annum to the tuition fees of up to £9,000 per annum in England.
Whilst there is a loan facility in place to help university students with these costs, many parents are concerned that their children may be leaving university with a substantial debt that may take years to repay. Indeed, due to the addition of interest, which can be as much as RPI plus 3% (5.5% in September 2014) the outstanding debt will increase for those with higher incomes in later life. And, of course, that outstanding debt may have a significant impact on another important financial issue for children – namely the desire to obtain a mortgage to purchase a house.
In order to give the child financial assistance at the right time, parents and grandparents should put savings in place. And the earlier the better. For many parents this will involve saving money on a regular basis. And, of course, when setting up a savings plan to provide for a child’s university costs, it is worth bearing in mind that the more tax efficient the investment, the greater the potential return at the required date.
And the good news here is that the Government has given this whole area a huge boost in the 2014 Budget with the introduction of its new tax free savings plan, the NISA.
The main rules that apply to NISAs are now as follows:
- All adult ISAs are now known as NISAs (new ISAs).
- The maximum contribution in 2014/15 is £15,000 for an adult NISA and £4,000 for a Junior ISA (still known as a JISA).
- There is no longer a 50% maximum contribution limit on cash investment: an investor can place their full £15,000 in a cash NISA.
- The rule which permitted a transfer from a cash ISA to a stock & shares ISA, but not the opposite, has been scrapped. NISAs can be transferred in either direction.
- The investment rules have been relaxed to allow short-term bonds with less than five years to maturity to be held in a stocks & shares NISA.
- The flat rate 20% tax charge on interest on cash in stocks and shares NISAs has been abolished.
The Government is also examining how to include peer-to-peer loans as permitted investments for NISAs.
The changes that have turned ISAs into NISAs have made them more attractive and flexible products. The key to making the most of NISAs – as with ISAs – is to keep contributing. That way, over time it is quite possible to build up a six figure portfolio free of UK income tax and capital gains tax (although 10% dividend tax credits cannot be repaid).
How much is needed?
The amount of cash needed to see a student through university can be substantial. Let’s take a parent who wishes to advance fund for the university costs of their three-year old daughter. They estimate they need to target a total £57,000 (based on current values) ie. £19,000 per annum (tuition fees of £9,000 per annum and living costs of (say) £10,000 per annum.) for 3 years, in 15 years’ time. Based on a growth rate of 5% per annum net and ignoring tax on any encashed amounts, this would mean that a lump sum of £27,418 would need to be invested now. Alternatively, the parent could pay £215 per month. However, should costs increase by 2% per annum (not unrealistic), the cash needed in 15 years’ time would increase to a whopping £76,714.
So what savings vehicle should be used to fund for this? For many parents (and grandparents), it will frequently be the case that regular saving is the only option. So given the improvements that have just been announced, a sensible starting point should therefore be the JISA and then the NISA.
(1) The Junior ISA
The Junior ISA:-
– is available for any child under age 18 who does not have a CTF account. Therefore the child must have been born before 1 September 2002 or after 2 January 2011
– permits contributions of up to £4,000 per annum. These contributions would normally be paid by a relative, such as a parent or grandparent
– can be invested in cash funds and/or stocks and shares and
– provides tax freedom on capital gains and investment income (although the tax credit on dividends cannot be recovered).
Although the proceeds are not accessible until the child gets to age 18 that can fit in nicely with the plan proceeds being used to fund university costs as we explain below.
The Junior ISA will enable a parent to invest £4,000 per annum. If the full £4,000 is invested each year for 18 years then, assuming growth at 5% net per annum and ignoring ongoing charges, this will produce a tax free fund of about £118,156 after 18 years – more than enough to cover the current cost of the three-year university degree course we refer to above.
The obvious benefits of the Junior ISA are that it is tax free. In the case of parental contributions, because the £100 parental settlor income tax rule will not apply, income arising in the Junior ISA will never be assessed on the parents and will, in effect, accrue tax free.
The downside is that there is no control over the child’s ability to access the fund at age 18 and, of course, they may not then be university material!
Parents or grandparents who are concerned about this point could consider keeping any investment in their own name until the child attends university. Appropriate investments here could be the “parental” ISA (see (2) below) or growth collectives (see (3) below).
(2) Parental NISA
Here it is contemplated that the parent would effect the NISA in their own name and therefore keep complete control over the time when the NISA is encashed.
For a taxpaying investor, it is still undoubtedly the case that the NISA is still the main method of investing savings with freedom from income tax and capital gains tax without giving up the flexibility of access to the investments.
Because, as we explain above, the new NISA now permits a contribution of up to £15,000 per annum which can be split in any proportion between the cash and stocks and shares elements. This means a couple could between them invest £30,000 each year.
Of course, no tax relief applies on the payments into a NISA but income and capital gains are free of tax. The tax credit on a dividend is not recoverable and so, for the basic rate taxpayer, a NISA invested in equities gives no income tax advantage. However, for a 40% taxpayer, tax freedom means the net dividend income yield improves by 25% and for a 45% taxpayer by 43.9%.
The tax efficiency of a NISA is that investments have scope to accumulate in value at a faster pace. The earlier a programme of NISA savings is established the better. Moreover, “own- name” NISAs will enable the parent to automatically exercise control over the timing of any encashment of the NISA and the application of the NISA proceeds.
(3) Growth-oriented unit trusts/OEICs savings plans
Given the relatively high current rates of income tax as compared to the current rates of capital gains tax (CGT), it can make sense from a tax standpoint to invest for capital growth as opposed to income. This is particularly the case for the higher/additional rate taxpayer. A regular monthly saving into a growth-oriented unit trust/OEIC may therefore be appropriate.
Although income (dividends and interest) on collectives is taxable – even if accumulated – if this can be limited then so can any tax charge on the investment. Instead, if emphasis is put on investing for capital growth, not only will there be no tax on gains accrued or realised by the fund managers, it should also be possible to make use of the investor’s annual CGT exemption (currently £11,000) on later encashments. This would enable the investor to enjoy a stream of tax-free capital payments that can be used to meet university costs. Gains in excess of the annual exempt amount only suffer CGT at 18% and/or 28% currently (depending on the investor’s income tax position). For couples, it makes sense for each of them to invest in order to be able to use both annual CGT exemptions when investments are encashed.
Of course, as for all financial planning, a careful balance needs to be struck between investment appropriateness and tax effectiveness. While investment performance through capital growth is obviously tax attractive, reliance on growth at the expense of income can introduce (possibly unacceptable) risk.
For all of the investments mentioned above, if and when the investment or the proceeds are transferred to or used for the child, IHT would need to be considered. Where parents or grandparents wish to make the transfer earlier (eg at outset), but retain some control over who receives the benefit and by when, some form of trust may be considered.
Action
If you are interested in advance funding for university costs, a JISA, NISA and/or unit trust/OEICs savings plans can be a tremendous benefit.
Call us for more information on the planning to meet your circumstances and objectives.
Past performance is not a reliable guide to the future. The value of investments and the income from them can go down as well as up. The value of tax reliefs depend upon individual circumstances and tax rules may change. The FSA does not regulate tax advice. This newsletter is provided strictly for general consideration only and is based on our understanding of law and HM Revenue & Customs practice as at January 2011 and the contents of the 2010 Comprehensive Spending Review. No action must be taken or refrained from based on its contents alone. Accordingly no responsibility can be assumed for any loss occasioned in connection with the content hereof and any such action or inaction.
Autumn 2014