A friend of mine, very sadly, is getting divorced. At the moment this divorce remains relatively amicable, with both sides being constructive and the financial matters largely resolved. But one key issue remains outstanding – how to provide for private school fees for the two young (aged between 5 and 10) children.
This couple are, relatively speaking, asset rich but income poor (though will both be higher rate tax payers). Based on anticipated regular income levels, private schooling would be unaffordable. But based on current net assets of over £3m, they think they can set aside funds to cover, at least partially, future schooling requirements.
The current annual cost of private school amounts to £40k p.a. for the two kids. The couple simplistically consider the total sum required until the children reach age 18 is £440k. This makes no allowance for inflation, let alone school fee inflation, but they don’t seem concerned about that. They had also been imagining leaving these funds in a cash savings account, rather than investing it in more productive assets. In theory these two assumptions feel like mistakes which will at least partially cancel each other out
The rub is that the amount of money they think they need would leave insufficient funds for my friend to buy their own home in the desired area. My friend wants to agree some cost-sharing agreement going forward, and not provide for all the future fees now, in order to fund a better house now. The other half wants to ringfence sufficient provision now, in some form of trust or dual signatory arrangement. I think they will agree to ringfence now, but they aren’t sure of how best to do it.
My friend has asked me for advice because they are intrigued by my recent ‘discovery’ of margin loans, and they are asking me whether they could ringfence a capital pot but then release some of it via a margin loan to buy the home she wants.
I’ve been pondering what they could do to optimise for security, taxes, risks, and don’t have a clear view on what these friends should do. It is in theory a simpler problem than providing for one’s retirement, because the timescale is clearer. But I still don’t see an obvious solution. I’d welcome suggestions via comments below.
At the moment my thinking is as follows.
I think some form of trust will be helpful, it it can ensure that any investment income is either tax-free or is in the childrens’ names.I don’t know for sure if this is possible; I believe if a third party (eg grandparent) funds the trust it is, but not if the parents fund it. Does anybody know how this works? And what would it cost to run, each year? I am assuming it could be managed for less than £2k per year. Is this a reasonable assumption?
One approach for a ‘school fees fund’ would be to invest the trust’s funds into a conservative investment portfolio of UK-based assets, with an income bias. For the sake of argument this might be 10:60:30 cash:fixed income:equities, with a target yield of 4%. This couple aren’t experienced investors (tho have both worked in the City for years) so my advice would be to choose a pair of ETFs/Unit Trusts from Vanguard/iShares/similar.
A margin loan against this school fees fund is probably not that helpful because as the school fees fund depletes the loan will trigger margin calls.
Another approach is to invest in a long-term asset such as a commercial property with say a 20 year RPI-linked lease. This holding could be mortgaged, at perhaps 60% loan to value. On this basis perhaps they could invest in a £1m (inc taxes) property yielding say 6% (is this still possible? It used to be), borrow £600k of that at say 4%, and be left with about £30k of income for 20 years and an asset at the end of it. However the mortgage needs to be repaid and there are some ongoing management costs.
There was a time that zero coupon bonds might have been an interesting solution but I haven’t heard about those for ages. Are they worth looking into?
One kicker they should look into might be to pre-pay school fees some years in advance. This fixes the fee and can, in some schools’ case, result in a hefty pre-payment discount too.
I’d love thoughts and suggestions that I can pass to my friend. What advice would you give this couple?