The Wire: Autumn 2021Why giving your child or grandchild a gift could be better than repaying their student loan

(Estimated read time 5 minutes)

Why giving your child or grandchild a gift could be better than repaying their student loan

Despite the Covid pandemic, top grades for A-levels reached a record high in 2021, resulting in more than 435,000 students being accepted onto UK degree courses around the UK.

While most students jump for joy, their parents or grandparents could ask a question many have asked before them: do I want my children or grandchildren to start their working life with substantial debt thanks to the student loan, and should I pay it off?

With its headline-grabbing interest rate of up to 5.6% a year, paying off their student loan seems logical. Yet the loans are not as straightforward as you may think and doing so could result in you paying thousands of pounds when you don’t need to.

Read on to learn how a student loan works, why it isn’t a typical loan and why paying it off could cost you dear in the long-term.

The Student Loan is not like a traditional loan it’s actually a graduate tax

For starters, stop thinking of it as a loan but consider it as a graduate tax, one that may or may not be payable depending upon earnings.

Unlike a traditional loan, the repayments on student loans do not start until your child or grandchild earns a certain level of income. In other words, the amount paid off is linked to the amount they earn after graduating, making it more akin to a levy or tax.

If they do not reach the threshold income level – more of this in a moment – they do not need to pay off the loan. And, if the loan is not cleared after a certain amount of time, the outstanding amount is written off.

In his Money Saving Expert article, Martin Lewis explains that many people earning more than the income thresholds will still not have to pay all their loan off. So, settling the loan could mean you’re paying back money that may never be due.

There are two different loan plans

If your child or grandchild is from England or Wales, and started university before September 2012, they are likely to be on the earlier loan scheme known as “Plan 1”. This could also be the case if they are Scottish or Northern Irish and started an undergraduate or postgraduate course in the UK after 1 September 1998.

If this applies to them, they will start repaying the loan once they earn more than £19,380 a year.

If the university course attended ran after September 2012, your child or grandchild will typically be on Plan 2. This means they repay the loan once they earn more than £27,295 a year (2021/22).

The table below outlines the key differences between the two plans, although please note that income thresholds and interest rates change annually.

Source: Gov.uk

The loans help cover tuition fees and, potentially, living costs

In 2021/22 the tuition fee for UK universities is £9,250 a year. This means a student loan for a three-year degree would be £27,750. This does not consider living costs that are typically covered by maintenance loans.

While you may be happy to fund your child or grandchild’s living costs yourself, you may also want to teach your child or grandchild about budgeting and encourage them to take a maintenance loan.

If the latter applies to you, you may already know that households with higher incomes have smaller maintenance loans available to them. In 2021/22, if your household has an income of more than £70,000 a year, the maintenance loan available will be £3,516 a year if the student lives at home, or £4,422 if they live away from home.

If they study in London the loan is £6,166 a year. This means a student loan could total around £46,000 if you’re a higher earner and your child or grandchild studies for three years in London.

Paying the loan off could be a complete waste of money

Using the above scenario of a £46,000 student loan and assuming your child or grandchild is on Plan 2, if they get a job paying £30,000 a year after graduation, they will repay 9% of £2,705 each year.

This is the difference between their earnings and the threshold income level at which repayments become applicable.

Assuming nothing changes, this means they will repay £243.45 a year, or around £7,300 after 30 years, resulting in the outstanding £38,700 being written off.

While this simple example does not consider salary increases and revised thresholds, they highlight an important point. If you repay the loan, you could pay back tens of thousands of pounds that may never become due.

In fact, making serious inroads to this debt only really starts once the student is earning serious money, £80,000 to £100,000 a year. That could be many years away.

Meanwhile giving a lump sum to your child or grandchild could be a better option

While it’s natural that you want to help your children and grandchildren as they start their careers, there could be better options than paying off their student loan.

For example, having a deposit to buy a home may be a more pressing concern for your child or grandchild than repaying their student loan.

Helping your child or grandchild onto the property ladder by giving them the money you would have used to pay the loan off may be more financially astute, and much more appreciated.

If a home isn’t high on their priority list, you could gift them the money to invest in their future.

Investing £46,000 means it could be worth £66,300 after 10 years with a growth rate of 4.5% per annum. This assumes charges of 0.75% a year without inflation being taken into consideration.

This could help buy a house, fund a wedding, or even help start a new business venture in years to come.

You could also make the investment more tax-efficient by using Stocks and Shares ISAs or even making a contribution to their pension. While the maximum you can contribute to an ISA is £20,000 in the 2021/22 tax year, you could contribute the total amount over a period of years.

The pension Annual Allowance means you can contribute up to £40,000, or 100% of your child or grandchild’s earnings, and benefit from tax relief. They will benefit from immediate tax relief on this contribution, and any investment growth over a period of perhaps 30 or 40 years.

Get in touch

If you are considering gifting money to your child or grandchild, we can help you understand your options. For the reasons explained here, it may be more beneficial to consider other means of gifting rather than paying off a student loan, so talk to us before you make any decisions.

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