I have two young children and this question and I have wondered if I should save for their university costs over the recent years. I also get this question from three distinct sets of clients:
- Grandparents who want to pass money to their family / grandchildren.
- Parents who want to save for their children’s futures.
- Parents/grandparents who have recently received a windfall, either by way of inheritance or property/asset sale.
The question goes to the heart of an individual’s psychological response to “having debt”. Therefore, there are no right or wrong answers, just pros and cons to be weighed up:
- Should they take a student loan?
- What about other costs like rent and bills?
- What’s the interest rate?
- When is it repaid?
- What’s the total Bill?
In England and Wales undergraduates who take a student loan will come under “Plan 2” for the student loan, this is different to undergraduates in Northern Ireland and Scotland.
The headline figures for “Plan 2” are:
- They only start to repay the loan once their income is over £26,575 pa.
- If they are above this threshold they repay pay 9% of their income towards the loan (this not the interest rate).
- Interest on the loan is linked to the Retail Price Index (RPI) from the first day that they get the loan.
- Under “Plan 2” – while they are studying – the interest rate is RPI plus 3%.
- Once they finish, if they earn less then £26,575 interest is the same as RPI.
- If they earn above £26,575, additional interest is added capped at RPI plus 3%.
The interest rates are updated each September in line with RPI from March of that year. So, for September 2019 RPI was 2.4%, which means “Plan 2” students accrue interest up to 5.4%, depending on their income. Students can check the rates on the gov.uk website.
On the face of it that is an eye-watering interest rate. Given that the Bank of England base rate is 0.10% at time of writing and borrowing is, historically speaking, “cheap” at present, paying 5.4% feels very expensive.
Cancellation of the loan
Under Plan 2, the loan will be cancelled after 30 years or if the student becomes disabled and permanently unable to work or passes away.
According to the Complete University Guide:
The balance of the student loan is cancelled after a certain time. This means student loan cancellation is likely for the majority of students – as long as you’ve kept up with any repayments due.
So, what should we do?
Weighing up the “expensive” student loan vs the likelihood of it being repaid is an important consideration. I think most of us would believe that by sending our children/grandchildren to university they are “more likely” to go into a higher paying career. However, there is certainly no guarantee of this happening and this can add additional pressure to a potential career choice.
Don’t take the loan
Imagine that they do NOT take the loan. Instead the family decide to pay up to £9,250 per annum for the cost of the degree. Then, for whatever reason, they are unable to secure a higher paying job.
They leave Uni “debt free” and able to start out on a career path without the borrowing hanging over them. The family would have spent at least £27,750 (3 years of study regardless of other living costs) to cover the university cost and they have not attracted that eye-watering interest rate.
Take the loan
An alternative could be to take the full student loan and you (parent/grandparent/family) hold onto the cash. You could save or invest this money in your own hands and retain full control over when the money is released and for what purpose.
If they go into a job with income over £26,575 pa, you simply draw the money you had earmarked and pay the loan off in one go. If this doesn’t look likely, you could keep the money invested or put it towards another goal like a deposit on a property.
In this case the interest on the loan (up to 5.4% in 2020) simply continues to build up and has no impact on their day to day life. It will not be taken into account if they apply for a mortgage or any other line of credit and will simply continue to accrue until 30 years have passed. At this point it is cancelled.
Where to save the money
Taking the loan could offer the family a range of flexible options for saving the £26,575. Making use of potential tax efficient savings wrappers like ISAs, pensions, offshore bonds or trusts could all then be factored in to build a family strategy for higher education.
If the family has 2 or 3 children/grandchildren this figure represents the best part of £100,000. This is money that could be put to better use, over what for some clients, is a 10,15,20 year education strategy.
If you are considering your options in this area please, please feel free to get in touch.