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Secret Tax Benefits of an Education Trust Fund

Jennifer Birtles 3rd Aug 2020 One Comment

Reading Time: 5 minutes

Trusts are often only associated with the extremely wealthy, but they can actually be beneficial to everyone. There are various different types of trusts out there, so finding which one is most suited to you is important and will depend on your personal circumstances.

However, for parents and grandparents, an education trust funds may be the way to go. The problem is that most parents haven’t heard of them, or are unsure how to set one up. If you have children in paid-for education, or will do in the future, then an educational trust might help alleviate some of the pressure of these costs, but also save you on tax, too.

what are education trust funds?

Education trust funds are a tax efficient way to provide for your family

An educational trust fund can be set up by parents to fund current or future school and university tuition fees. An education trust fund is available to the parents of any child, or children, up to the age of 25 who are, or will be, in full-time education. This type of fund differs to others as the beneficiaries are not in control of how the money is spent.

Although, legally, the settlor is gifting money into a trust, the documentation of the trust specifies that the funds are used to be explicitly for education. It is also part of the trust regulations that if any funds are not used for this purpose then they will return to the parent or their estate.

why you should consider one

One of the most common reasons to set up a trust is for their tax benefits – and in particular Inheritance Tax. An educational trust fund allows you to gift money for Inheritance Tax planning, but still gives you control over what it’s used for. To truly avoid Inheritance Tax though, the gift needs to be irreversible. If you still benefit from it you may be liable to pay Pre-Owned Asset Tax (POAT).

Funds within the trust can be invested in a very wide range of investments, and you can be a trustee yourself, which allows you control over how and when the funds are distributed. Educational trusts allow you to ring-fence funds for a specific purpose and minimise your tax bill. Money invested into these trusts are removed from your estate for Inheritance Tax purposes. They also don’t count as part of your estate in potential future problems, such as a divorce.

The fund isn’t exempt from tax, and any income payments paid to the beneficiary will be net of tax. However, the child will be able to reclaim the tax paid by taking advantage of their personal allowance (currently £12,500). After which, it will be taxed at a rate of 20% up to £50,000. This is a much more beneficial situation to where the fees are paid straight out of the parents estate, potentially subject to a tax rate of 45%, and this tax is not recoverable.

pros of an education trust fund

Why should you consider a fund?

  • Unlike gifting into many other trusts, you don’t have to wait a 7-year period before the gift drops out of your estate. With an educational trust, money deposited into it drops out instantly.
  • You are in control of the amount gifted into the trust.
  • Funds in an educational trust cannot be touched in case of problems such as divorce, bankruptcy, or insolvency.
  • An educational trust fund can also be set up to provide an income and capital, up to the age of 25, if the child, or children, are in full-time education.
  • Income Tax is normally paid within the investment and so avoids the completion of annual tax returns.

cons to consider

As with any financial investment, with the advantages come disadvantages, too.

  • Income earned on investments will initially be treated as yours for Income Tax purposes.
  • Funds are subject to Pre-Owned Asset Tax. The annual limit (£5,000) is the deemed benefit for each settlement. If the deemed benefit exceeds the annual limit then the whole amount becomes taxable. From 2017 the official rate of interest has been at 2.5%. Which means the current maximum you can have in an education trust without occurring POAT is £200,000. (200,000 x 0.025 = £5,000). This is assuming you’ve not used up your POAT allowance elsewhere.

set up an educational trust

How to set up an educational trust fund

A trust is legally binding and to ensure your assets and funds are secure you want to guarantee everything is done officially. Find a solicitor, and consider consulting a financial adviser too to discuss your options. This can be costly – a solicitor can charge upwards of £1,000 to set up a trust. However, if you’re seriously considering an educational trust fund then the money is worth spending. Trust documentation needs to be water-tight, legal, and secure.

alternatives to consider

There are other options out there for tax and inheritance planning to take into consideration.

discretionary trusts

A discretionary trust is one in which the beneficiaries and their entitlements are not fixed. Rather, they are defined by criteria set out by the settlor, and their distribution is at the discretion of the trustees.

These are a great option for grandparents also wishing to help out with education costs. Each person can give away £325,000 without incurring Inheritance Tax, or up to £650,000 in a couple. However, the money will only fall out of the estate once the 7-year period has passed and you cannot get the money back once it has been deposited into the trust.

To find out more about discretionary trusts, check out our article What is a Discretionary Trust?

bare trusts

With a bare trust the beneficiary is entitled to take control of the trust assets at 18. While this option wouldn’t be suitable for everyone as it depends on the responsibility of the child, it is an option worth considering. These trusts allow more freedom than educational trusts. The beneficiary can use the funds for further education if they wish, but they have no legal obligation to do so.

The benefit of a bare trust is that as soon as money is put into the trust the money is taxed as if it belongs to the child. Usually meaning there is no Income or Capital Gains Tax to pay. Also, any money paid into a bare trust will become a Potentially Exempt Transfer. If the donor survives seven years beyond gifting the money, then it drops from their estate for Inheritance Tax purposes.


It may surprise you to hear, but you can get a pension from the day you’re born. A pension can be taken out in the child’s name and anyone – parents, grandparents, other relatives – can contribute. Currently you can deposit in £2,880 a year, at 20% tax relief. Which means the child receives an extra £720 a year on top if the full amount is contributed. It’s very tax-efficient and is a great way of providing for your children or grandchildren well into their future.

For more information read Pension for Babies: Tax-Efficient Inheritance!

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3 years ago

Had no idea about paying into a pension as soon as a child is born. Interesting.

Jasmine Birtles

Your money-making expert. Financial journalist, TV and radio personality.

Jasmine Birtles

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