For this week’s Savings Guide, we have a special edition with Mark Chicken, a chartered financial planner at The Private Office, looking at how you can save your child from university debt…
For parents with young children, university can feel a very long way off.
But with graduates in England facing up to 40 years of repayments, it’s never too early to get ahead on setting your kids up for university.
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The average graduate now leaves university with a debt of £51,645, including tuition fees and maintenance loans, according to investment platform Lightyear.
Students starting courses today fall under the new Plan 5 system. They repay 9% of earnings above £25,000, and repayments can continue for up to 40 years before any remaining balance is written off.
That means children starting school now could still be repaying student debt in their sixties.
So, as parents, if you are in a position to put money aside for your child, could you meaningfully reduce the long-term cost?
First, let’s look at how the new student loans work
Student loans don’t work like traditional bank loans.
A graduate earning £45,000 today would repay around £1,800 a year under the rules. Over time, those payments can add up significantly, particularly given the length of the repayment period.
Should parents save in cash or invest?
Parents can save up to £9,000 a year into a Junior ISA in the child’s name, which can be held either in cash or invested. Known as a JISA, it’s a tax-free savings or investment account for children under the age of 18.
Top cash JISAs are paying up to 3.85%. For cautious savers, that can feel reassuring, particularly given the ups and downs investment markets can experience.
Over long periods, however, investing in a diversified global equity portfolio has historically delivered stronger returns than cash, albeit with more short-term volatility along the way.
“As a firm, when modelling over longer timeframes, we tend to use cautious nominal assumptions such as: Cash growing at around 1% per year and investments growing at around 5% per year,” Chicken explained.
“In practice, long-term returns from global stock markets have historically been higher than 5% per year, but we prefer to work on cautious assumptions when planning.
“Actual returns can vary significantly from year to year. The figures above are simply used to illustrate the long-term impact of compounding.”
Explained:
How to get started with a stocks and shares ISA
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The £15,000 choice
While today’s cash JISA rates are attractive, interest rates can change over time, and many people fall into the trap of leaving their cash to languish in poor paying accounts, rarely switching.
Using those assumptions (1% cash and 5% investments), the difference over 18 years can be considerable.
Take this example…
To build a pot of at least £51,645 over 18 years:
“As you can see from the above example, long-term investment growth has the power to do a lot of the heavy lifting. It still requires regular saving, but the effect of compounding means a meaningful portion of the final pot can come from investment returns rather than direct contributions,” Chicken said.
“Ultimately, cash plays an important role in protecting capital in the short-term. But over longer-term periods, it has often struggled to keep pace with inflation.”
How can you manage risk as university approaches?
The example above shows how, over the long term, a diversified global equity portfolio can offer the potential for stronger growth, albeit with periods where values fall along the way, Chicken said.
When university is many years away, those short-term ups and downs tend to matter less. But as the point at which the money is needed approaches, market falls become more relevant.
For that reason, it may be sensible to choose to reduce investment risk gradually in the final few years before university, for example, by moving part of the pot into cash, to lessen the risk of a market downturn just before fees are due.
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Junior ISAs v Parent Owned Accounts
One of the main advantages of using a JISA is that investment growth is free from income tax and capital gains tax. Over 18 years, that tax efficiency can make a meaningful difference.
The trade-off is loss of control. At age 18, the money legally becomes the child’s. Parents ultimately have no control over how it is used and spent.
An alternative is to invest in a parent’s own name in, for example, an ISA or even a general investment account. These accounts legally remain the parents’ assets, but they can be notionally earmarked for a child’s future.
“The benefit of this route is flexibility. Parents keep full control over how and when money is distributed. If a child decides not to go to university, the pot could instead contribute towards a house deposit or other milestone,” Chicken said.
The drawback is that unless the money is in an ISA, the parents will pay tax at their usual rate – be that income tax or capital gains tax.
In this case, if you have one parent who pays a higher tax rate than the other, it could make sense to put the funds into their name to minimise the tax due, though you should seek advice when considering how to do this.
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Who wants to make their baby a millionaire?
For those lucky enough to have more to save for their child, it’s amazing how much can be gifted at age 18.
If parents or grandparents were to save £9,000 a year into a JISA, assuming growth of 5% a year, by age 18 that child could have a tax-free lump sum of nearly £266,000, Chicken said.
If the child then transferred their JISA funds into an adult ISA at 18 and left it until retirement, it could grow to almost £1.8m if left untouched until age 57.
If you want to give your child a huge boost to their retirement, contributing to a pension can be a good alternative, though the funds cannot be accessed until age 57 (assuming no change to current legislation).
In depth: How to make your baby a millionaire
Even if the child has no income, pension contributions still qualify for basic rate tax relief on total contributions of up to £3,600 a year.
So this can be affordable for many families as a maximum gross contribution of £3,600 each year until age 18 costs £2,880 net annually (£51,840 over 18 years), with the government adding £720 in tax relief each year (£12,960 in total).
Assuming 5% growth until age 57, and even with no further contributions after 18, the pension could still reach £737,000.
“There are lots of options for parents who can afford to put something away regularly for their children – and starting early can make it easier to ease at least some of their future financial burdens,” Chicken added.
