04 April 2023
For most of the last decade, the start of a new tax year brought small increases to net pay for employees as tax allowances and thresholds were uplifted. As we enter the 2023/24 tax year, there won't be a change in take-home pay for the vast majority of employees as the main income tax allowances and thresholds have been frozen until April 2028. As the cost-of-living crisis continues, those with student loans may not realise the potential longer-term consequences on their finances due to this and other changes to the tax system in recent years.
Many graduates who started their studies between 1 September 2012 and 31 July 2023 will be on a ‘plan 2’ repayment scheme in relation to their student loan. In broad terms, that means that they will start making repayments of their loan when their income exceeds the student loan repayment threshold. The repayments are at a rate of 9% of income over the threshold.
The majority of students with plan 2 loans outstanding are likely to be millennial and gen z graduates – individuals born on or after 1981. Some may be approaching their 30s and their eighth year of student loan payments.
For previous generations, any student loans received may well have been paid off by this time. However, many millennials and gen z graduates may not realise that following the tax changes and the increases to interest rates in recent years, they may now be stuck with their student loan for the maximum 30-year period.
The current student loan repayment threshold for existing plan 2 loans is £27,295. That has been increased from £21,000 in the 2017/18 tax year. For many graduates, it means that they are unlikely to make any substantial repayments in the early years of their career until their earnings exceed the threshold. On the face of it, it means students keep more of their earnings but with interest rates increasing, they are likely to be storing up a larger problem down the line.
To illustrate the point, let’s take the example of someone with an outstanding student loan of £25,000 with seven years of repayments behind them. The maximum interest rate on plan 2 student loans is currently 6.9%. If we assume interest rates remain at this level and that tax rates and thresholds also stay the same, the loan would never be repaid by an individual who remains on a £50,000 salary.
Such an individual will be better off each year following the tax changes made since 2017/18 to the tune of approximately £2,300, primarily due to increases to the basic rate band and personal allowance, albeit we have seen significant inflation since then so individuals may not feel the benefit of this. However, assuming an average interest rate of 5.5%, a plan 2 loan holder in 2017/18 on a £50,000 salary might have reasonably predicted they would repay their student loan in full in around 13 years. In contrast, and following interest rate rises, such a graduate faces another decade of repayments.
The taxation changes in recent years have benefitted many graduates in terms of their take-home pay. Unfortunately, the short-term gain could well be outweighed by long-term pain as millennial and gen z graduates remain in student loan purgatory.