Should I pay off my student loan?

Tristan Noyes considers whether repaying a student loan (or repaying your children’s loan) is a good idea. Graduates leaving university in 2026 typically start their working life with around £50,000 in student loan debt. Repaying a student loan seems, on the face of it, like a good idea; you pay interest on the loan, so repaying it reduces the interest. On the current Plan 5 (students starting since August 2023), the interest rate is currently 3.2%, but for those on Plan 2 (students starting Sept 2012 to July 2023), the rate is higher, ranging from 3.2% to 6.2% depending on income.

Decisions, decisions…

Due to the way student loans are repaid, overpaying may not always make sense; repayments are based solely on the graduate’s income above a threshold and collected at 9%. The current threshold is £28,470 for Plan 2, and £25,000 for Plan 5. Repayments are collected alongside income tax, either through PAYE or through self-assessment (or both for people with multiple sources of income), so the system operates similarly to a ‘graduate tax’ (i.e., a higher rate of tax for people who studied at university).

Consider a graduate with £50,000 of Plan 2 debt now earning £60,000 per year. They will pay 6.2% interest and repay 9% of income above £28,470. That’s an annual interest of £3,100 and repayments of £4,638. Although the loan will be reduced, it will take around 18 years to fully repay. If their income goes up, the loan will be repaid more quickly, but the interest at 6.2% continues to accrue.

For this person, overpaying the loan makes sense, particularly if they expect their income to increase over their career. Compare that to the identical graduate earning £35,000 per year. Their interest is around 4.1% or £2,050 per year, with repayments totalling £588 per year. That means their debt is increasing each year. Student loans are written off after 30 years, and this person (assuming their income does not increase rapidly) will never pay off the loan.

Any overpayments they make will just reduce the amount written off and are unlikely to save them any money in the short or long term. Instead, the ‘repayments’ are really akin to an extra tax of £588 for 30 years. As is often the case, the answer to the question of whether to overpay or repay student loans is ‘it depends’, mostly on how much the graduate is
expected to earn over their career, and how long they have left until the loan is written off.

Other nuances of the system

• ‘Side hustle’ – do not forget that if you have other income alongside your main job, this may also be liable to student loan deductions, payable via self-assessment. The combination of income tax, National Insurance contributions and student loan repayments can lead to very high marginal tax rates.
• ‘Lumpy’ income – repayments apply to all income, including bonuses. Do not get caught out with unexpected deductions on extraordinary income. Consider smoothing income over tax years.
• Pension contributions – on the flip side, pension contributions reduce income liable to student loan repayments, so can be increasingly tax-efficient, particularly for people in the example above who will likely never realistically repay their student loan.
• Final year of payment – the employer simply deducts 9% above the threshold income without knowing the balance of your student loan. This can mean that in the final year of repayments, you could materially overpay and need to have it refunded by the Student Loan Company.

Practical tip

If you are liable for student loan repayments, think carefully before overpaying. As a 9% ‘graduate tax’, it is worth considering the impact of techniques such as smoothing income and making pension contributions. As the loan gets close to full repayment, consider making a lump sum or switching to direct debit in the penultimate year to avoid overpaying via PAYE for a full tax year
year.

Disclaimer: The information provided on AccountingFirms.co.uk is for informational purposes only and should not be considered as financial advice. Always consult with a professional accountant to ensure compliance with UK laws and regulations.