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Can the bank of mum & dad combat rising student loan costs?
The recent changes announced to student loans, due to come into force in September 2023, have raised significant questions around the cost of university and the future burden placed on graduates.
The new rules can increase the costs by up to 50% and upon graduation (once a graduate is earning over £25,000) there will effectively be a 9% tax applied to all earnings above this threshold. With student loan debt increasing rapidly every year (totaling £206 billion as of March 2023 (Parliament, 2023)) and only 54% of people clearing their debt after 40 years, this might not be the last we see of government action to tackle student debt.
These changes have raised further questions for parents and grandparents who may be conscious of a future burden from further education and uncertainty about how they can provide support. The average student will leave university with £45,600 of loan debt, with the addition of interest charges, which could take them almost all of their working life to pay off. To further add to this, the debt has an impact on an individual's ability to borrow money in the future (for example when taking out a mortgage) as loans are based on gross income after deductions.
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The system itself already assumes that parents are able to supplement maintenance payments. For most students who are below age 25, their maintenance loan is based on their parents’ income and the expectation that any extra income required is provided for by the parents.
So, what are the options that can be considered? And how could this help with potential tax bill in the future.
Option 1 – Personal loan to your child or grandchild
You may see value in loaning your child or grandchild the value of their debt and perhaps look to formulate an agreement for repayment on less stringent terms than Student Finance England. The upside to this is the flexibility and affordability to the student, and as a parent or grandparent you’re not losing capital, although you may need to put in place a formal agreement (i.e. it would need enforcing). On this point it is important to bear in mind that the new system is a tax, so it is only worth considering for those earning above the basic rate tax threshold and this would still be considered a debt in regard to future loans.
Option 2 - Gifting
There are many different forms of gifting that you can make use of to support family members and potentially mitigate an inheritance tax burden.
Inheritance tax is tax paid on the value of your estate when you die. Individuals have a tax-free allowance, known as the nil rate band, of up to £325,000, or £650,000 for a married couple. In addition to this, it’s possible to pass down the family home to direct decedents with an additional allowance known as the residence nil rate band, which currently stands at £175,000 per individual. This means that up to £500,000 per person can be passed or up to £1million for a married couple totally free of inheritance tax.
As a parent or grandparent, you may be considering passing wealth through generations and leaving your inheritance for your children or grandchildren. You may therefore consider helping them out during your lifetime, rather than after you’re gone, so they can clear this ongoing debt in the early years, post-graduation. This also allows you to see your loved one's benefit from the fruits of your labor while you’re still around to enjoy it.
The Gifting Options
Gifting out of income – the ability to gift money free from inheritance tax provided it’s from surplus income (all income minus expenditure) and that this does not impact your standard of living. You may decide to do this on an annual basis and help to accelerate the pace to which they pay off their loan or if you have an influx of income in one year, pay off a more significant proportion as a lump sum.
Gifting outright – Another option is gifting a lump sum of money all in one go once your child/grandchild has completed university, as you will know the full value of their debt. This is known as a lifetime gift, for inheritance tax purposes, and providing you live for 7 years after the date of gift was made, this gift will be outside of your estate and therefore free from inheritance tax. This concept is further detailed in our article ‘The exemption that could save you 40% on tax!’ This provides you with the scope to pay off the student loan immediately after university and relieve your child/grandchild from the debt for the foreseeable future.
Utilise your annual gifting allowance - each person is allowed an annual gifting allowance of £3,000 per annum, which can be gifted each year free from inheritance tax. It can be carried forward if it has not been used in the previous year giving an allowance of £6,000 per person to gift. This allowance could be used towards paying a lump sum per annum towards the student loan and does not make you liable to potential inheritance tax.
Further considerations
It is important to be realistic about your child or grandchild’s perception on university or reasons for going. If you choose to fund them the whole way through university, will they take it seriously? If you decide to pay the tuition fees for them from the outset – will you feel strongly if they decided to drop out? If you supported them throughout their years at university, supplementing the maintenance payments, would this limit your ability to assist in settling the debt that they complete university with?
What we can do to help
Seeking the assistance of a professional financial adviser can help you determine the most affordable and suitable way of gifting and supporting your children or grandchildren when taking into account your long-term plans and overall wealth. We can construct a cash flow forecast to formulate a plan for the remainder of your life, to determine where the best places are to draw your monies and at what point you may decide to distribute your wealth to your loved ones to mitigate inheritance tax. We can help to articulate the proportion of surplus income you have to gift with and bring to life the impact of gifting on your cash flow.
As this is such a significant decision for a family it is important that the appropriate decisions are made at the right times, to ensure your standard of living is not impacted but your objectives, in terms of providing for your family, are met.
We’re offering anyone with £100,000 or more in savings, investments and pensions a free financial review worth £500. So why not get in touch and see if we can help you.
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The information contained within this article is for guidance only and does not constitute advice which should be sought before taking any action or inaction. The information is based on our understanding of legislation, whether proposed or in force, and market practice at the time of writing. Levels, bases and reliefs from taxation may be subject to change.
