What's expensive and saves money?
The waning of the old financial year is marked by the growing hype surrounding PEPs (personal equity plans) with advertisements exhorting people to cash in on dazzling tax breaks. But financial advisers are urging caution, particularly if the PEPs are destined to pay school fees.
"People see the words 'tax free' and rush to jump in, but you have to remember that equity-based PEPs can go down as well as up," said Brian Walmer, assistant director of Bowring Financial Services, which specialises in school fees. "And you don't want your investment going down just as you're facing bills for sixth-form education, for instance."
If parents can afford to wait 10 years for the cash, he suggests the more traditional route of taking out with-profits endowment policies. These are not tax-free but they are less volatile; they can be set up so that the pay-outs cover the projected fees each year. Families who can afford to put down a lump sum can set up an educational trust, which is tax-free and has a guaranteed rate of return; the only drawback is that it must be used for education, otherwise parents become liable for tax on the profits.
But only a minority of parents with children at independent schools plan far enough ahead to take advantage of endowment schemes, or have enough cash to pay into an educational trust. In fact, three-quarters of parents meet school fees out of existing income, according to Anne Feek, managing director of the School Fees Insurance Agency (SFIA).
She says that most parents only consider the actual costs when term starts, despite termly fees ranging from around Pounds 750 to Pounds 3,000 in prep schools and between Pounds 1,100 and Pounds 4,000 in senior schools. The growth in fees, which always runs at slightly above inflation, does not appear to have deterred parents.The proportion of the total school population attending independent schools rose from 5.8 per cent in 1979 to 7.2 per cent in 1994, according to ISIS, the Independent Schools' Information Service.
For parents with at least three years to wait before fees are due, SFIA offers a fairly cautious PEP specifically designed for the payment of school fees and university costs. SFIA's PEP Education Plan offers a choice of six funds, all from mainstream investment houses and including a corporate bond PEP. Assuming an annual growth rate of 9 per cent, a couple with a one-year-old child could meet all her secondary school fees by paying Pounds 240 a month into an SFIA education plan until she is 18.
Although equity-based PEPs will perform better in the long term, corporate bond PEPs are more secure as the dividend is determined by prevailing interest rates, rather than by the company's performance.
A mix of corporate bond and equity-based PEPs could be the answer, according to Maurice Fitzpatrick, senior tax consultant at the accountants Chantrey Vellacott. He thinks the tax advantages of PEPs are overwhelming, particularly for the 9 per cent of the population who are higher-rate taxpayers, and who probably include most independent school parents. PEP investors pay no tax on the maximum of Pounds 9,000 they can invest each year, and no capital gains tax.
PEP charges are also generally lower than charges for endowment policies. Another advantage of investing in a scheme which is not linked to education is flexibilty; the dividends can be used for anything, which could be useful if the parents decide to use the state sector after all.
But for a combination of security and tax efficiency, a package of different investment schemes might be ideal. For someone planning five to 10 years ahead, National Savings, TESSAs, PEPs and conventional with-profit endowments all have their part to play, according to Louise Challis, head of the school fees practice at Bowring Financial Services. Less far-sighted parents could take out a loan at around 4.9 per cent secured on their home, or at 4.5 per cent above base rate, if it is secured on an insurance policy.