The investigation could result in educational trusts losing their charitable status, and could leave thousands of people faced with finding an alternative method of saving for their children's schooling.
Educational trusts are offered by insurance companies or independent financial advisers. Parents pay a lump sum into the trust, a registered charity, which is then used to purchase annuities that will pay for the child's education. Because the trusts arecharities, higher-rate taxpayers benefit from a 15 per cent tax break.
A spokeswoman for the Charity Commission said: "We are concerned about the commercial use of these trusts as a means of paying school fees on an individual basis."She said the commission had prepared a preliminary report, but was continuing to consult the industry about the trusts.
Sun Life, one of the biggest providers of educational trusts, has temporarily withdrawn from marketing its product until the position is clarified.
Save & Prosper also offers a product. Duncan Grant, S&P director, said: "We have supplied the Charity Commission with details and discussions are going on."
The Inland Revenue is keeping a watching brief on the situation. A spokesman said that it was taking its lead from the commission.
School Fees Insurance Agency, an independent financial adviser, operates many educational trusts that pay out about £30m in school fees every year. Ann Feek, managing director, said: "We can only hope that they will not touch those schemes already in existence." She said educational trusts would not be viable if they lost their tax benefits.
As well as the threat posed by the Charity Commission and the Revenue, the Labour Party has announced plans to take away charitable status from private schools. This could add about 8 per cent to the cost of educating children privately.
Bearing these points in mind, people should start saving as soon as possible for their children's private education. Isis, the independent school information service, said parents should not be unduly alarmed by the threatened increase in fees. Dick Davison, Isis spokesman, pointed out that Labour's policies on private schools have changed several times.
"In the most general way, we think that getting rid of charitable status would put up fees by 8 per cent. About 1,100 from the total of 1,360 are charities."
Isis was pressing for an immediate meeting with David Blunkett, Labour's education spokesman, to see whether there was room for negotiation on the party's stance.
"It would need almost a redefinition of charity law," Mr Davison said.
Until recently, Isis recommended a scheme run by an independent financial adviser called Claremont Savile. The scheme, which was taken on by about 8,000 parents, used a draw-down facility on equity in people's property to provide income for school fees. However, earlier this month Claremont Savile was suspended by its regulator, Fimbra, because of lack of financial resources.
Isis now plans to operate a scheme with Bowring Financial Services. Richard Ferguson, Bowring Financial Services chairman, said: "We are planning to put together a similar type of scheme to that offered by Claremont Savile." Claremont Savile's existing 8
,000- strong client base will now be serviced by Lines Partnership, based in London.
People wishing to start saving for their children's education now have a variety of methods of funding to choose from. Moores Marr Bradley, an independent financial adviser, specialising in school fees , estimates that the cost of educating three children at private school at today's prices could be as much as £300,000.
School fees can be financed through the use of an educational trust, via a series of lump-sum payments, through regular savings or by using a scheme to release equity in the parents' property. The type of plan chosen will depend on the income of the parents and their other financial planning requirements.
SFIA's Ann Feek said that a mixture of investment plans could be used. "Many people finance some of their school fees from income and use a savings plan to top up."
Paul Gauntlet, a Moores Marr Bradley consultant, suggested National Savings certificates for people who have only a few years until the children start school.
"I would recommend the five-year, 8th issue index-linked certificates, because they guarantee a tax-free rate of 3 per cent above the rate of inflation." Other National Savings products may not be such a good bet because they carry rates that are fixed at the outset, and interest rates may rise over the term.
Where there are more than five years to the first year of education for the child, Mr Gauntlet recommended regular savings in a low-risk personal equity plan with a low front-end charge. "For example, we might recommend the M&G Managed Income PEP, which has no front-end charges."
With no front-end charges investors begin to see a return on their money earlier. Mr Gauntlet also recommends Murray Johnstone and Fidelity as they carry lower-than-average charges.
"With-profits endowments are less attractive because you may not have immediate access to your funds without penalty. They also have a less favourable tax position," he said.
Ms Feek also recommends a PEP offered by Fidelity.
For people with regular lump sums to invest, Mr Gauntlet favours Prudential's with-profits bond. "Prudential's product has a slightly lower than normal level of charges, and it begins to credit terminal bonuses earlier on in the life of the bond."Reuse content