Learning the lessons of paying for an education

Such provision can leave a major dent in family finances and so invest as early as possible and involve as many family members who may like to contribute.

The costs can be daunting. Taking a typical day school, the fees alone for 14 years could amount to 188,000 to which 1,000 annually could easily be added to cover such expenses as uniform, school trips and extra lessons.

If taking the schools attended by the Prime Minister and his deputy, Eton and Westminster respectively, expect to pay considerably higher sums.

As the chart shows, privately educating two children could exceed 405,000, assuming 3,358 per term when starting and six per cent annual growth in fees.

This is for day pupils and borders could pay three times the rate.

Besides seeking a scholarship or means-tested bursary (listed in the Educational Grants Directory published by the Directory of Social Change), there are several options:

Use existing savings;

Take a tax-free lump sum or taxable income from a pension fund;

Pay the school in advance for a discount;

Either remortgage or release equity from your home, which could involve a 'lifetime mortgage';

Establish a trust, possibly using an insurance policy which would state how the money was to be used.

The life assurance approach is probably the simplest, lowest risk and most cost-effective. For grandparents who finance such a policy, they can rest assured that even if they should not survive to see the youngster complete their education, they are leaving a sizeable nest-egg to help.

Bursars are increasingly keen to accept fees in advance but check that the school will keep the money in a separate account in the event the school closed or went into difficulties.

Payments in advance are placed on deposit and the interest earned is enjoyed as a discount. Through their charitable status, private schools earn interest on a tax-free basis.

This means the discount is appreciably higher than the interest you would have enjoyed personally.

Assuming a plan is started as soon as possible after a baby's birth, if there is a lump sum available, the money should not be constrained but placed where above-average returns can be enjoyed, notably the Asian, emerging and US markets.

After three to four years, it would be sensible to place one or two annual fees aside either in conventional gilts (government stock) or index-linked gilts.

Martin Payne, Leeds director at stockbrokers Brewin Dolphin, would then use corporate bonds with good yields, like Vodafone 5.5 per cent or a well managed fund like Old Mutual Corporate which returns both capital and income to the portfolio.

"Corporate bond fund income could be automatically reinvested into additional units for the medium term, utilising the power of compounding returns," tips Payne.

For the medium to longer term, opt for UK equities with "decent and sustainable dividend yields", says Payne. This could be directly – with blue chips like Glaxo, Royal Dutch Shell, Tesco or Unilever – through investment trusts (notably Dunedin Income Growth, Edinburgh or Standard Life Equity Income Trust) or unit trusts, like Artemis Income or Invesco Perpetual High Income.

Since some of the money will not be required for 17 years, the portfolio could be diversified to include property, resources – such as gold and oil – structured products and hedge funds.

It is vital to have a trusted independent financial adviser who can ensure assets are switched in good time to protect capital, reduce risk but generate sufficient income to pay the fees.

Jonathan Baker, of Charles Stanley stockbrokers in Leeds, has noticed that increasing numbers of grandparents are helping with school fees. He recommends collectives (like investment trusts) but also life assurance bonds, where five per cent can be withdrawn annually without incurring penalties.

He recommends not to forget that the Inland Revenue allows gifts to be made out of 'normal' after-tax income. This is separate from inheritance tax. To qualify, the gifts must mean that there is enough income after making them to maintain your normal lifestyle.

Wherever possible – particularly if funding fee provision from income – take the tax-efficient route, particularly:

ISA (Individual Savings Account) where up to 20,400 annually can be sheltered by a couple where the income and gains are free of UK income and capital gains taxes but the 10 per cent tax credit on dividends from UK companies is not repayable;

Tax-exempt friendly society savings plan which can be up to 50 monthly for a couple, opting for 10 or more years (such as with Sheffield Mutual, Druids Sheffield or Wakefield-based Kingston Unity);

EIS (Enterprise Investment Scheme) provides instant income tax refunds up to 100,000. It aims to support smaller companies and attracts 20 per cent relief on up to 500,000 provided it is invested for three years;

VCT (Venture Capital Trust) gives 30 per cent income tax relief on annual investments up to 200,000 each.

Schools are sensitive to the economic crisis. Last year Wellington College allowed parents to defer or spread fees even after a pupil had left and secure any debt against the family home.

When selecting collective funds like unit trusts and open-ended investment companies, examine past performance as well as the current management. The brokers Bestinvest have recently published a guide to the best and worst (available from 020 7189 9999).

Their so-called 'dog' funds reveal Martin Currie Emerging Markets to have lost investors 24 per cent compared to the benchmark over three years and Scottish Widows Emerging Markets was close behind. Instead opt for Aberdeen Emerging Markets or First State Global Emerging Market Leaders.

In Asia Pacific, which offers so much potential, the best performers were First State Asia Pacific Leaders and Aberdeen Asia Pacific & Japan.

Bestinvest says there are four dog funds in this sector: Lloyd George Asia Pacific, Premier Alliance Trust Asia Pacific Equity, Henderson Asian Dividend Income (ex New Star) and Baring Eastern.

School fee costs

Year Child one Child two Extra Total

fees fees expenditure*

2011 3,490 n/a 1,000 4,490

2012 10,469 3,445 2,020 15,934

2013 10,880 10,335 2,060 23,275

2014 11,306 10,741 2,102 24,149

2015 11,750 11,162 2,144 25,056

2016 12,210 11,600 2,187 25,997

2017 12,689 12,054 2,230 26,973

2018 13,187 12,527 2,275 27,989

2019 13,704 13,018 2,320 29,042

2020 14,241 13,529 2,367 30,137

2021 14,800 14,059 2,414 31,273

2022 15,380 14,611 2,462 32,453

2023 15,983 15,184 2,512 33,679

2024 16,610 15,779 2,562 34,951

2025 11,282 16,398 1,294 28,974

2026 11,138 11,138

Total187,982 185,581 31,948 405,511

*for uniforms, extra lessons, school trips

Assumptions: 2010 school fees 3,358 per term, two per cent inflation, six per cent growth on school fees, five per cent second child discount.

Source: Brewin Dolphin