Is a degree worth it? How to beat the tax trap

Deciding whether to go to university has never been more important, with high participation rates and student loans putting pressure on the average graduate’s earnings prospects. A 9% loan repayment adds to tax burdens, but there are ways to manage this. Here’s how.

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UK tuition fees are capped at £9250 per year, but according to forecasts from the Institute of Fiscal Studies the average graduate is still anticipated to leave university with debts of more than £50,000.  More than 70% of these graduates are forecast to never pay off their entire balance, which is written off after 30 years. 

Currently, graduates start to repay their loans at a rate of 9% of salary, once their earnings exceed an earnings threshold of £25,000. This means that someone earning £27,000 will pay £15 a month (£2000 x 9% = £180 a year). Factor in interest payments (a political hot potato) and it’s easy to see why most debts will never be repaid.

Whether it is worth going to university will depend on the individual. Someone earning £20,000 a year will never have to pay off any of the debt at all. Many higher earners could not have got their jobs without a degree, and therefore will end up paying the loan back relatively quickly, but it is those middling earners — the majority — who have a starker decision to make. Could they have got their job without a degree, and how much of a long—term impact on their finances is a 9% tax rate over and above £25,000?

In a previous article we wrote about how rising UK inflation had caused wages to stagnate since the year 2000. It’s not an exaggeration to say that choosing a university course that adds long—term value has never been more important.

What does a student loan cost you?

Whether you see loan repayments as the repayment of an outstanding debt, or instead a ‘graduate tax’, is a moot point. It’s a simple fact that anyone earning more than £25,000 will have a further 9% deducted from their wage packet for the majority of their working career. 

This 9% contribution is money that could have been invested into a pension, house, shares, or any other asset that might go up in value. That money has an ‘opportunity cost’.

Let’s say you graduate at 22, expect to earn an average of £40,000 a year over the first 30 years of your career, and then retire 15 years later aged 67. How much money could you have saved and invested?

The annual loan repayment would be £1350, which if invested in equities (100 year returns for UK equities have been 5% above inflation) could be worth — in today’s money — £90,000 in 30 years’ time and £186,000 by age 67.

Taking the example further, if your average earnings were £50,000 this could amount to £311,000 by age 67; a considerable sum to supplement state and workplace pensions.

Will that 9% loan repayment really hurt?

It may seem like a little, but when added to National Insurance Contributions (NICs) and income tax, the tax burden for graduates is quite substantial. The table below illustrates this: it is 41% at £25,000, 51% at £50,000 and 71% for earnings over £100,000 due to the tapering of the personal allowance.

Add on Employer’s NICs of 13.8% and a graduate earning £50,000 effectively has a marginal tax rate of 64.8%, keeping 35.2p in the pound. If you plan to have children, this number goes up.

Adding to the tax pressure, marginal tax rates for households with someone earning more than £50,000 increase further as child benefits are tapered away at a rate of 1% of the child benefit for every £100 of income.

If you have two children, you would qualify for benefit of £1788 a year, £20.70 per week for child one and £13.70 for child two. An earner on £51,000 would effectively be paying an extra 17.9% in tax on that £1000, making their marginal tax rate 68.9% or 82.7% once the 13.8% Employer’s NIC is included.

Marginal tax rates for UK workers 2018/19

Income (£) Base tax (income and NIC) plus 9% loan repayment plus 13.8% employer NIC
10,000 12% 12% 25.8%
20,000 32% 32% 45.8%
30,000 32% 41% 54.8%
40,000 32% 41% 54.8%
50,000 42% 51% 64.8%
60,000 42% 51% 64.8%
70,000 42% 51% 64.8%
80,000 42% 51% 64.8%
90,000 42% 51% 64.8%
100,000 42% 51% 64.8%
110,000 62% 71% 84.8%
120,000 62% 71% 84.8%
130,000 42% 51% 64.8%
140,000 42% 51% 64.8%
150,000 42% 51% 64.8%
160,000 47% 56% 69.8%
170,000 47% 56% 69.8%
180,000 47% 56% 69.8%

(Source, IG, June 2018)

Salary sacrifice into pensions and SIPPs is one solution

Salary sacrifice is an agreement with your employer to pay wages or bonuses straight into your pension. Many — but not all — employers will also pay their 13.8% Employer NICs into the pension as they no longer have to pay it to HM Revenue and Customs.

Salary sacrifice is also a legitimate way to not make student loan repayments, which means that an earner on £51,000, with two children, could make a £1138 payment into their pension and forgo £311 of net pay, an astonishing day one uplift of 265.9%.

While this is the best it can get (ignoring those earning over £100,000 who are not eligible for free nursery care), it may make sense to strategically use salary and bonus sacrifice to top up pensions, delaying loan repayments, in the knowledge that the student loan will disappear in 30 years’ time.

If this hasn’t filled you with despair, our beginner’s guide to investing in a SIPP and the rather more optimistic pensions investing: when should you stop are both useful references for people at the wealth accumulation stage of their life.

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