Same income, different student loan repayments. Is the system fair?

How student loan repayments are collected

Most people repay their income-contingent student loans through the tax system. There are two exceptions where the repayments are collected directly by the SLC and not by HM Revenue & Customs (HMRC) – if you go abroad for more than three months or if you are in the final 23 months of loan repayments you should be able to set up a direct debit with the SLC.

HMRC collects student loan repayments if earnings for National Insurance purposes are above the relevant repayment threshold per pay period (if an employee) and/or over the tax year if you fall under the Self Assessment tax system. 

The repayment thresholds for the different plans are set each tax year by the relevant devolved administrations and there are currently different repayment thresholds for the five different income-contingent loan types (known as Plan 1, Plan 2, Plan 4, Plan 5 and Postgraduate loans)  ranging from £21,000 to £33,795.  We cover which loan plan you will fall under and the repayment thresholds for each plan in our website guidance.

The repayment rate of 9% above the repayment threshold is the same across all loan plans, with the exception of the postgraduate loan plan for England and Wales which is 6%.  The postgraduate loan plan is also different to the other loan types as it is paid concurrently alongside other income-contingent loans, potentially resulting in a repayment rate of 15% above the relevant thresholds.

The issue of using different mechanisms to collect tax

Student loan repayments are usually calculated by looking at earned income, that is income from employment or self-employment, but there is an exception for unearned income over a certain amount (see the heading Unearned income below).

The actual amount of student loans repaid could vary depending on how deductions such as tax, National Insurance contributions and student loan repayments are collected by HMRC. This could lead to borrowers under Self Assessment making higher loan repayments than someone earning the exact same amount of income but having their tax collected through the Pay As You Earn (PAYE) system.

Repayments collected under PAYE

The PAYE system is a method of paying tax on certain types of income such as from employment and pension income. However for student loan repayment purposes, pension income is not included when using the PAYE collecting mechanism and so employment income only is used when calculating repayments.

As explained above, earnings for student loan purposes are calculated in the same way as they are for National Insurance contributions. This is not always the same figure as the earnings on which income tax is paid. 

If a Self Assessment tax return is not required, HMRC will calculate any loan repayments on employment income only on each payday. This means that if a borrower has two unconnected employments the repayment threshold is applied to each employment separately and not by considering the total employment income.

Repayments collected under Self Assessment

Student loan repayments are calculated differently under the Self Assessment tax system, which also includes the Making Tax Digital for income tax reporting system. 

Under Self Assessment, total earned income, and in some cases unearned income (see heading Unearned income below), is used when calculating any student loan repayments. Total earned income includes employment income as well as income from self-employment.

Inconsistencies in calculating repayments

So variances can arise as the PAYE system of collecting student loan repayments will usually focus on each individual employment only, whereas under Self Assessment all earned income is used when calculating loan repayments. The following example illustrates this.  

Unearned income

As can be seen above, student loan repayments are broadly calculated on earned income such as from employment or self-employment. However, where a borrower has ‘unearned income’ such as rental income or savings income and consequently must complete a Self Assessment tax return this income could be included when calculating student loan(s) repayments.

Unearned income is only taken into account when calculating student loan repayments under Self Assessment if:

• there is more than £2,000 unearned income in the tax year, and
• the total income is above the relevant repayment loan plan threshold. 

Importantly, the £2,000 amount is a ‘cliff-edge’ threshold. This means if there is over £2,000 of unearned income then all of this income will be included when calculating the loan repayments. 

However, if there is unearned income above £2,000 but the borrower is not required to submit a Self Assessment tax return, then this amount is not included when calculating student loan repayments. This means the treatment of unearned income can result in a discrepancy in the calculation of loan repayments depending on whether tax is collected through PAYE or Self Assessment. This is illustrated in the example below.

It is also worth highlighting that the £2,000 unearned income ‘cliff-edge’ threshold has not increased since income-contingent loan repayments were first introduced more than 25 years ago. This lack of inflationary uprating contributes to the deemed unfairness between the amount of loan repayments borrowers under the Self Assessment system must pay compared to those taxed solely under PAYE.

Final thoughts

Student loan repayments are intended to be income-contingent, but as the examples above show, borrowers with similar levels of income can face different repayment outcomes depending on the source of that income and whether their repayments are calculated solely through PAYE or through Self Assessment. This raises questions about whether the current rules produce fair and consistent outcomes. We have heard from a number of taxpayers who have been affected and feel this part of the current system is unfair.

The treatment of unearned income creates a further disparity. Under Self Assessment, unearned income of £2,000 or less is disregarded, but once it exceeds £2,000 the whole amount can be brought into the student loan calculation. That ‘cliff edge’ can produce significantly different results for people whose financial circumstances may otherwise look very similar. ‘Cliff edges’ are not unique to the student loan system. While they may be simpler to administer than alternatives such as tapering, they can produce markedly different outcomes for taxpayers in otherwise similar circumstances and can therefore give rise to concerns about fairness.

This disparity between the amounts of repayments under PAYE vs Self Assessment is likely to increase as the number of borrowers increases each year and also due to changes such as the rise of ‘side hustles’ resulting in more people being required to complete a Self Assessment tax return - although the increase in the trading allowance from £1,000 to £3,000 is helpful here. There could also be a further impact as the duration of repaying student loans before they are written off is now 40 years for the new Plan 5 loans compared to 30 years for some other loans, such as Plan 2 and postgraduate loans. This means that newer borrowers are likely to be in the loan repayment system for longer and therefore may have more opportunity to be taxed under the Self Assessment system.

The key question is if student loan repayments are income-contingent, should two borrowers with essentially the same income have materially different repayment liabilities simply because of the source of that income or the mechanism used to collect the tax? From a pure fairness perspective, the answer is perhaps no.

There is a counter argument that because student loans are not a tax, (although there is a popular school of thought that they should be regarded as a type of ‘graduate tax’), does it matter if there is an unfairness in how the repayments are calculated based on the mechanism HMRC uses to collect tax and other deductions? One potential justification for why it does indeed matter is that many borrowers never fully repay their loans before they are written off, so this leans towards a requirement for greater fairness in how loan repayments are calculated when comparing the PAYE and Self Assessment tax systems.  

At the very least, there is a strong case for looking again at whether the interaction between the student loan and tax systems produces consistent outcomes, and whether longstanding features such as the ‘cliff-edge’ £2,000 unearned-income threshold remain appropriate.

¹ From the SLC Annual Business Plan 25-26 (page 13)