Full marks or must do better? The new plan for student loans

06 June 2023

This summer sees the introduction of a new student loan system, Plan 5, for those starting their courses from 1 August 2023. With many graduates facing the reality of making repayments for longer with rising interest rates, we compare the current Plan 2 student loan scheme with the new Plan 5 regime. 

The shortcomings of Plan 2

To take an illustration under Plan 2, assuming a £25,000 loan and an average rate of interest of 6% (retail price index at 3% on average plus 3%), an individual earning a salary of £40,000 throughout their working life (or the 30-year repayment period) will never repay the loan in full. At the end of the 30-year period they will have paid circa £34,000 (effectively in additional tax). The balance of the loan, or cost, written off by the government will be circa £53,000. This excess is in effect the extra interest that will have been charged on the loan that remains unpaid after 30 years. 

The figures are worse for the government’s financial bill of health if you were to look at someone who earns an average salary of £30,000 throughout their working life/the 30 years repayment period. The total repaid would be circa £7,300 and the balance left to be written off by the government circa £124,000! 

Clearly these figures just don’t add up. But with the interest rate so high, the average worker will repay less each year than the interest charged. For someone earning £55,000 a year it will still take 16 years for the loan to be fully repaid (after interest of circa £14,000). It will take 13 years for someone earning £60,000 a year to fully repay the loan (after interest of circa £11,000). On top of this, there aren’t many careers offering a starting salary anywhere near these levels. 

The new Plan 5 

Three principal changes will be introduced under the new Plan 5, presumably aimed at addressing the current inherent mismatch:

  • The threshold at which an individual starts to repay their student loan will be reduced from £27,295 to £25,000 (based on the 2023/24 tax year);
  • The repayment period for the loan will be extended from 30 years to 40 years;
  • The interest rate charged on the loan will be based on the retail priced index (RPI) instead of RPI plus 3% as under the current Plan 2. The interest charged is effectively to ensure that the loan is adjusted for inflation.

The combined effect of the measures will mean that more of the amounts borrowed will be repaid and the costs written off by the government should be significantly reduced. For example, to illustrate a comparison, assuming the same £25,000 original loan and an average RPI of 3%, an individual earning £40,000 a year will repay the loan in 28 years having paid interest of circa £12,000.  

An individual on a £30,000 salary will still not have repaid the loan in full within the extended 40-year repayment period but the remaining cost incurred by the government is circa £48,000 (compared to the £124,000 under the Plan 2 provisions). 

A regressive plan 

What is harder to reconcile with the new Plan 5 is that it will disproportionately impact those on lower wages. Individuals with a Plan 5 student loan will pay circa £207 more each year compared to a Plan 2 Student Loan, resulting in an increase in the effective rate of tax of 0.69% for someone earning £30,000 a year. The increase in the effective rate is just 0.34% for those earning £60,000 a year. 

This goes against the idea of a progressive tax system and the rhetoric we heard from No.10 and No.11 in November 2022 that “those with the broadest shoulders should be asked to bear the greatest burden”. Indeed, based on the same illustrations which assume a £25,000 loan and RPI of 3%, someone earning £30,000 throughout the maximum 40-year repayment period would repay £18,000 under than the terms of the new Plan 5 before the balance of their loan is written off. Under the terms of the Plan 2 loans they would pay circa £7,300 (circa £10,700 less).  

In comparison, whilst those on higher salaries will see more deducted from their salary each year under the Plan 5 Scheme compared to the Plan 2 Scheme, they may find themselves better off overall under the Plan 5 Scheme as they are likely to take less time to pay off the loan. 

Camilla Taylor
Manager, Private Client Services
Camilla Taylor
Manager, Private Client Services