Wealth Check: 'Should I pay off my student debt now or later?'
Saturday 21 August 2010
Michael Brooks graduated from university this year and recently started working as a junior project manager for Unilever. He is currently earning £24,000 per year and lives with his parents in Hemel Hempstead.
Having just finished his studies, he is worried about how to clear his student debt. "Despite being careful with my spending at university, it has left me with a large student debt and very little in my current account," he admits. He wants to know if he should be making overpayments on his loan now while interest rates are low.
Michael, 21, is also planning to rent his own property in London within three years, and hopes to buy within seven years. However, with the high house prices in London and the little savings he has, he is unsure how to achieve this goal. Thinking about the future, Michael wants to know if he should be paying more into a retirement scheme now.
Annual income: £24,000
Annual expenditure: Tax and NICs: £5,516.35
Living expenses: £1,800
Other costs: £3,880
Advice this week comes from Nick Evans of One Life Wealth Planning, Diane Weitz of Ashlea Financial Planning, and Lorreine Kennedy of CareMatters...
Michael has done well getting a place on a graduate scheme and is earning a much higher salary than the average graduate. The fact that he is considering retirement schemes so thoroughly is both impressive and unusual, says Kennedy, as the average age of starting a pension in the UK is 28.
However, Evans warns that Michael must look at the broader picture and consider his short-term goals before putting additional payments into a pension scheme.
"Money saved in pensions means it's not available for other things," he points out. "It therefore comes down to the timescales Michael sets himself to achieve other savings goals such as a car or house deposit. That said, an additional £100 per month into a pension now would pay huge dividends in the long term."
Michael's pension scheme is particularly valuable, says Weitz. "It's a career average scheme which takes a contribution of 5 per cent salary from the employee and provides benefits of 1/60th of his salary for the current year. It means each year that Michael remains with the company he will gain a defined benefit of 1/60th of that year's salary."
Kennedy suggests that Michael could make larger contributions now if he wishes but says "as his immediate needs are to generate liquid assets, I would not recommend tying up his money to age 65 other than by making the current 5 per cent payments".
Michael should take advantage of the tax-free interest in an ISA and use the annual cash allowance of £5,100 to save for emergencies and buy a car. Weitz says that the best rates are currently around 2.7 per cent, so Michael should check his account matches that. She also recommends that he increases his monthly savings to make the most of an ISA.
"As Michael's salary increases, the savings will become increasingly valuable, as the interest is free of tax," she says. "I would recommend building up an emergency fund of around £12,000. Saving £200 a month into the ISA over four years, in addition to the lump sum of £2,000, should produce around £12,300 at current rates."
A deduction of £65 a month, or £780 a year of Michael's salary is being made though PAYE towards his student loan. Although the loan interest was 0 per cent for a short period of time last year, it is not going to rise dramatically and so will remain a very cheap form of debt. Evans recommends that Michael pays off his overdraft before he worries about paying off his student loan for that reason.
"While it may go against his natural instinct, there is an argument to suggest Michael should consider using his savings to pay off your overdraft immediately. Even if you delayed any new savings for a while, it's still likely to take you at least three months to clear your overdraft just through income," he points out.
Buying a property
Kennedy warns of the difficulties of taking first steps on the property ladder. "As a first-time buyer Michael will need savings of around £25,000 to provide a deposit and fees associated with house purchase," she warns.
"Without parental support or financial encouragement from the government Michael may find himself in a similar situation as many other first-time buyers – unable to buy for the foreseeable future." However, she recommends that he takes advantage while living with his parents to save as much as possible.
For a free financial check-up, write to Wealth Check, The Independent, 2 Derry Street, London W8 5HF; or email email@example.com
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