Can I pay more into my pension to reduce my student loan repayments? Steve Webb replies

I have a student loan which I repay via my salary every month. However, I owe a lot and the accumulating interest means the balance is going up rather than down. 

I don't think I will pay it off before the balance is wiped after 30 years. 

Is it worth paying more into a pension to reduce student loan payments if you think you will never be able to pay off the loan?

And what's the difference for a basic and higher rate taxpayer?

Steve Webb replies: It is not often that I find myself writing about graduate finance in a column about pensions and retirement. 

But your question raises an interesting issue for younger workers trying to make the best financial choices for the future.

In this case, you are asking if paying more into a pension might reduce the amount you have to pay now in student loan repayments. 

This would make saving into a pension better value for you than for someone else who didn't have any student debt to think about.

The simple answer to your question is that, in many cases, paying more into a pension would not have any impact on how much student debt you had to repay - but there is a possible exception. 

For those who are taxed via the Pay-As-You-Earn (PAYE) system, the amount of their student loan repayment is generally calculated on the basis of their gross pay - the total amount they earn before any deductions. 

If you pay into a pension in the normal way your gross pay is unaffected, and hence your student loan repayments are unaffected.

However, if you have the opportunity to pay into a pension via what is called salary sacrifice then this would reduce your gross pay, and save you money on student loan repayments.

How does pension salary sacrifice work? 

I've written more fully about salary sacrifice for pensions previously, but the basic idea is that you do a deal with your employer which means you agree to accept a lower salary in exchange for the employer making all the pension contributions. 

The purpose of this kind of arrangement is generally to reduce the amount of National Insurance contributions made by both you and your employer.

But a byproduct of salary sacrifice is that it reduces your gross pay and hence the Student Loan Company applies a lower deduction towards your student debt.

If you thought that you would one day clear your student debt, then paying it off more slowly might not be a great idea.

This is because paying it slowly means more interest builds up and you may end up paying back more overall.

But in your question you suggest that this is a situation where you do not expect you will ever clear the balance and that it will eventually, close to retirement, be written off.

Is it a good idea? 

In this case, if salary sacrifice for pensions is on offer in your workplace and you have not so far taken it up, it would be well worth considering whether a combination of the National Insurance saving and the saving on student loan repayments would make it an attractive deal.

I should mention however that from April 2029 there is going to be a cap on pension salary sacrifice arrangements. 

From that date, anyone sacrificing more than £2,000 per year in the form of employee contributions would not get any NI saving on amounts above this ceiling. 

This doesn't mean that there is no advantage from salary sacrifice, but it does limit the maximum amount you can gain. 

The government hasn't yet clarified the position with regard to student loan repayments – but there is a risk that your ability to reduce these through salary sacrifice will also be capped.

However, not everyone in work is taxed via PAYE, and the self-employed may instead be taxed via filling in a tax return. 

In this case, HMRC knows more about you than your employer does and a different way of working out student loan repayments is used. 

It is more like the definition used for income tax purposes and in this case pension contributions are deductible. So paying more into a pension should mean a lower loan repayment.

Finally, you asked whether the answer to the question is different for those who pay basic rate income tax and those who pay at a higher rate.

In short, the answer is no. The rate of student loan repayment on any extra £1 of earnings doesn't depend on whether you are a higher rate taxpayer or a basic rate taxpayer, so the impact of any deducted pension contributions would be the same in either case.

Of course, those who pay tax at higher rates get more up-front help with pension saving than those on lower rates, but this is true regardless of whether you have a student loan to repay as well.