Let’s end the student loans misconception - before it costs us our retirement

17 September 2018
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Paying off student loans above key life goals is just a bad idea.

Pensions provider Royal London recently ran the numbers on how the average graduate could expect their retirement savings to perform over the course of their working life.

Assuming our average graduate saved the minimum required by auto-enrolment – 5% of their salary from 2019 – in their workplace pension, by the time they reached state pension age they would have amassed around £148,000 in today’s money.

But if said graduate were to opt out of their pension in favour of paying off their student loan, they risk seeing their retirement savings shrink by more than half, from £148,000 to just £73,000, with the average student ‘debt’ of £40,000 taking 21 years to pay off.

In this scenario, graduates also miss out on tax relief on pension contributions. From the next financial year, auto-enrolment contributions will be set at a minimum of 5% of an employee’s salary, a 3% contribution from employers, and tax relief from the government of 20% on top – an effective £20 bonus for every £80 you put in.

Graduates not only miss out on valuable pension saving years, they may also pay more for their student debt. If a workplace runs a salary sacrifice scheme, for instance, the graduate would avoid paying extra student debt contributions in the same way that other tax burdens are mitigated, while more would flow directly into a pension pot. 

Student debt is not actually debt

While Royal London’s figures are just estimates, there is a significant problem at play. And that comes down to the misconception that student debt is actually debt.

Because in fact, the way that student debt repayment is structured means that it functions more as a tax on income than as a form of debt.

You’re only obliged to spend 9% of your income on repaying the loan once you’re earning over the current minimum threshold of £25,000 a year.

"Paying off student loans above key life goals is just a bad idea"

Student loans also won’t affect your credit rating. While mortgage lenders look at your income and expenditure – including your student loan repayments – they don’t view it as a 'debt' when assessing eligibility for a loan.

Plus, unlike real debt, it vanishes after 30 years. You could have £40,000 of debt or £4 million, it doesn’t ultimately matter because, either way, the debt is cancelled 30 years after graduation.

Three quarters will never pay it off

According to research from the Institute for Fiscal Studies (IFS), as many as three-quarters of graduates are unlikely to ever pay off their student loans in full.

The system in practice is also actually quite progressive. A nurse with £40,000 of debt will likely never pay back as much as a stockbroker with the same amount. This is because the stockbroker is likely to earn a lot more money and pay back the entire loan ahead of the 30-year deadline, whereas the nurse will likely only pay back a much smaller amount and have much of it written off.

But the use of the word ‘debt’ is particularly unhelpful, as it is misleading millions who go into further education. It risks causing real issues, through simple misconception, for an entire generation of workers as they go through their financial lives.

As Royal London warns, opting to pay down student loans ahead of other key life goals, such as a pension or a deposit for a house, is just a bad idea. It risks setting you back years behind your targets unnecessarily. 

If we all paid a straightforward 30-year ‘graduate income surcharge’ instead, there would be less complexity, less unfounded fear of debt, and likely a greater ability to save for house deposits and retirement.

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