For this week’s Savings Guide, we have a special edition with Chartered Financial Planner Mark Chicken of The Private Office on how you can save your child from university debt…
For parents with young children, university may seem a long way off.
But graduates in England face up to 40 years of repayment, so it’s never too early to get the go-ahead to enrol your children in university.
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According to investment platform Lightyear, the average graduate now leaves university with debts of £51,645, including tuition fees and maintenance loans.
Students starting the course today come under the new Plan 5 system. They repay 9% of earnings over £25,000, and repayments can continue for 40 years before any balance is written off.
This means that kids who just started school can still repay student loans in their sixties.
So, as a parent, if you’re in a position to set aside money for your child, can you meaningfully reduce the long-term costs?
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 pay around £1,800 a year under the rules. Over time, those payments can increase significantly, especially given the length of the repayment period.
Should parents save or invest cash?
Parents can save up to £9,000 a year in a Junior ISA in the child’s name, which can either be held in cash or invested. Known as a JISA, it is a tax-free savings or investment account for children under 18 years of age.
Top Cash JISAs are paying up to 3.85%. For cautious savers, this may be reassuring, especially given the volatility in the investment markets.
However, over the long term, investing in a diversified global equity portfolio has historically delivered stronger returns than cash, albeit with greater short-term volatility along the way.
“As a firm, when modelling over longer timeframes, we use cautious nominal assumptions such as cash growing about 1% per year and investments growing about 5% per year,” Chicken explained.
“In practice, long-term returns from global stock markets have historically been more than 5% per year, but we prefer to work on cautious assumptions when planning.
“Actual returns may vary significantly from year to year. The above figures are used only to reflect the long-term effect of compounding.”
Explained:
How to get started with a Stocks and Shares ISA
£15,000 option
While today’s cash JISA rates are attractive, it’s important to note that interest rates can fluctuate over time, leading many individuals to leave their cash in poorly paid accounts with infrequent switching.
Using those assumptions (1% cash and 5% invested), the difference over 18 years could be considerable.
Take this example…
To build a pot worth at least £51,645 over 18 years:
- Saving in cash may require contributions of around £220 per month
- Investment may require around £150 per month
- That’s a difference of £70 per month, or more than £15,000 in total contributions over 18 years
“As you can see from the example above, long-term investment growth has a lot of lifting power. It still requires regular savings, but the effect of compounding means a meaningful part of the final pot can come from investment returns rather than direct contributions,” Chicken said.
“After all, cash plays an important role in protecting capital in the short term. But in the longer term, it often struggles to keep pace with inflation.”
Photo: iStock
How can you manage the risk as university approaches?
The above example shows how, over the long term, a diversified global equity portfolio can provide strong growth potential, even during times when values decline, Chicken said.
When university is years away, those short-term ups and downs don’t matter. But as the point of need for money approaches, market declines become more relevant.
For this reason, it may be wise to gradually reduce investment risk in the final few years before university, such as by transferring part of the pot to cash just before fees are due, to mitigate the risk of a market downturn.
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Junior ISAs vs parent-owned accounts
One of the main benefits of using a JISA is that investment growth is free from income tax and capital gains tax. In 18 years, that tax efficiency could make a meaningful difference.
The trade-off is loss of control. At age 18, the money legally belongs to the child. Ultimately parents have no control over how it is used and spent.
One option is to invest in the parent’s name, for example, in an ISA or ordinary investment account. These accounts legally remain the property of the parents but can be hypothetically set aside for the child’s future.
Chicken said, “The advantage of this route is flexibility. Parents have complete control over how and when the money is distributed. If a child decides not to go to university, the pot can instead contribute to a house deposit or other milestones.”
The drawback is that unless the money is in an ISA, the parent will pay tax at their normal rate – whether it’s income tax or capital gains tax.
If one parent pays a higher tax rate than the other, placing the funds in that parent’s name may help reduce the tax payable, although you should seek advice when considering how to do this.
Who wants to make their child a millionaire?
If a parent or grandparent manages to save a substantial amount for their child, they may be surprised to see the potential gift at age 18.
If a parent or grandparent were to save £9,000 a year in a JISA, assuming 5% growth per year, the child could have a tax-free lump sum of around £266,000 by the time they turn 18, Chicken said.
If the child transferred their JISA funds to an adult ISA at the age of 18 and left it until retirement, it could grow to almost £1.8 million if left untouched until the age of 57.
If you want to give your child a huge boost for their retirement, contributing to a pension may be a beneficial option, although the funds cannot be accessed until the age of 57 (provided there are no changes to existing law).
In-depth: How to make your child a millionaire
Even if the child has no income, pension contributions are still eligible for basic rate tax relief on contributions totalling up to £3,600 per year.
So this could be affordable for many families, as the maximum gross contribution of £3,600 each year until the age of 18 costs £2,880 net annually (£51,840 over 18 years), with the government adding £720 in tax relief each year (total £12,960).
Assuming a 5% increase until age 57 and no further contributions after age 18, the pension could reach £737,000.
“There are plenty of options for parents looking to keep something consistent for their kids — and starting early may make it easier to ease at least some of the financial burden on their future,” Chicken said.
