Should Parents Repay Student Debt?

Many parents are keen to help their children fund their university education, but this may not be the best use of financial support. In fact, some parents who pay their child’s tuition fees or repay student loans may simply be subsidising other taxpayers. Their money might be better spent dealing with other priorities. Here we explain who can benefit by paying their loan off early and who should use their money in other ways.

The confusion around student finance arises from the terminology used by the Government and The Student Loan Company. Student loans are not like other debts, they are a graduate tax which lasts for up to 30 years post-graduation. Any loan not repaid by then is cancelled. The Institute of Fiscal Studies calculates that only 30% of student debt will be repaid in full, the other 70% is written off.

The interest rate charged on loans depends upon when the loan was started. Before September 2012 the interest rate is 1% over Bank of England Base rate, so currently 1.1%. For those who took their loan from 1 September 2012 onwards, the rate is 3% plus RPI, so currently 5.4%, with the inflation element adjusted annually in September based on the inflation rate at the previous March. Repayment starts from April following graduation. 

While the interest rate charged adds to the debt it does not alter the amount which the graduate has deducted from earnings. Repayment is based upon the earnings of the graduate with 9% of income (6% on postgraduate loans) over the earnings threshold collected through PAYE, or self -assessment for the self -employed.  Until the whole loan is repaid, the graduate will see no reduction in monthly deductions from their salary and gain no immediate cash flow benefit from early partial repayment. 

The table below sets out the terms of each loan plan
 

Loan Type	Earnings Threshold £	Deducted from earnings above threshold	Interest Rate
Plan 1 (pre-Sept 2012)	19,390	9%	Bank of England base +1%
Plan 2 (post Sept 2012)	26,575	9%	3%+RPI
Postgraduate	21,000	6%	3%+RPI

Earnings thresholds are usually revised each year in line with inflation.  When income is below the threshold nothing is payable and the interest rate on post 2012 and postgraduate loans falls to RPI only. Graduates who suffer a loss of earnings, so that tax year earnings are below the threshold, may make a claim for a refund after the end of the tax year by contacting the Student Loan Company on 0300 100 0611. 

Alternatives to student loan repayment

• Repay other loans such as credit cards, overdrafts and hire purchase loans, these will not be written off.
• Saving for a first home and if eligible for the Lifetime ISA, (under age 40) up to £4,000 per year may be paid into an account, to which the Government adds 25% up to £1,000 per year.
• If an employer offers a pension scheme with matching contributions, topping up pension savings may be a better option. Personal contributions are usually boosted by   tax relief and total contributions can be made tax efficiently up to £40,000 per year (more in some cases). Personal contributions receive tax relief up to the level of your earnings (or £3,600pa if more).
• Pension savings made by salary sacrifice reduce income which counts towards the income threshold. 

To Pay or Not to Pay? 

To illustrate how the student loan scheme works in practice we have set out below case studies. In all cases we have assumed that the student takes out the maximum fee and maintenance loan for students outside of London, leaving them with a debt of £58,686 on graduation. We have assumed average inflation of 2% and average earnings increases of 2.5%, the actual rates and repayment amounts may be different, depending on actual rates of inflation and earnings growth.

Graduate 1 Starts work on a salary of £19,000 pa, increasing by 2.5% pa thereafter. 

None of the student loan is repaid as earnings do not exceed the repayment threshold and the debt is written off after 30 years. 

Graduate 2  Starts work at £40,000 pa, increases 2.5% pa then to £70,000 in year 5 and by 2.5% pa.  thereafter. 

It will take 26 years for graduate 2 to repay the loan if they just pay the amount required under the scheme with a total cost of £114,924. Graduate 2 would be better off to clear the loan earlier.  

Graduate 3  Starts work at £25,000 pa, increases to £40,000 after 2 years increasing by 2.5% pa, then leaves work 5 years later to start a family. They restart part time work 19 years after graduation and earn £35,000pa.  

Graduate 3 pays back £5,980 of the loan, their earnings do not exceed the earnings threshold when they return to work and after 30 years the debt is written off. They are better off just paying the minimum required each year. 

Whether paying back student loans early makes sense depends upon personal circumstances and future earnings patterns. For most graduates taking a wait and see position would be logical with only those who expect to have continuously high earnings for 30 years considering early repayment. 

Kay Ingram

Please remember, no news or research item is a recommendation or advice to buy. Aspira Corporate Solutions is not responsible for accuracy and may not share the author’s views. If you are unsure of the suitability of any investment or product for your circumstances please contact an adviser. All investments can fall as well as rise in value so you could get back less than you invest.

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