Plan 2 student loans: a tax on aspiration?
The Plan 2 student loan system is not only unfair, but introduces perverse incentives that act as a brake on growth and productivity. Change is overdue, says Simon Wilson
What are Plan 2 student loans?
Plan 2 is the official designation for the student-loan system in England and Wales that was in place for students from 2012 to 2023.
Under the system, higher-education students take out loans to cover tuition fees and living costs, although parents are expected to chip in for the latter.
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They leave university with average loan debt of around £53,000, but this can be far higher for those undertaking longer or more advanced degrees.
The repayment system is complex, in that the “loan” is really a hybrid of a loan and a graduate tax that rich families can opt out of by paying up front, and repayment levels depend on the size of your earnings, not the size of your debt.
You only start paying the loan back once you hit a certain annual income (currently £28,470 for Plan 2), at which point 9% of income over that threshold is taken from your salary.
And if you don’t earn enough?
If you never earn that much, or have periods out of work, you don’t make repayments. Moreover, any remaining debt gets written off 30 years after graduating. Defenders of the system say that makes it quite a generous offer.
The problem is that while you are not making repayments – during your early career, or during a parental career break, say – the debt continues growing, making it ever harder to fully repay it and hence normalise your income tax rate.
Even for many middle-income workers, the high interest rate means that monthly repayments (in the form of salary deductions at source) fail to cover monthly interest payments, and capital debt continues to grow.
Indeed, in the last tax year overall, £15.2 billion of interest was added to loans, but only £5 billion repaid, and the government expects that only 32% of loans created last year will be paid off in full. Overall, the value of outstanding loans at the end of March 2025 reached £267 billion and is projected to hit £500 billion by the late 2040s.
How is Plan 2 different?
Graduates with Plan 2 student loans, especially those who earn more, are charged much higher interest rates than those who studied either before them (Plan 1, 1998-2011) or since then (Plan 5, since 2023).
(The other existing plan numbers are 3 for postgraduates, who pay extra, and 4 for Scots who studied elsewhere in the UK.)
Both of these cohorts pay 9% extra income tax (with a slightly lower starting threshold), but their interest rate varies in line with the Retail Price Index (RPI).
Thus, their debt pile rises with inflation, albeit the higher RPI measure of inflation that is widely regarded as discredited and is no longer used for uprating state benefits.
For Plan 2, the interest rate is RPI + 3% while you are studying, and once graduated it’s on a sliding scale between RPI and RPI + 3% (once income is above £51,245).
The idea was supposedly “progressive”, in that it was intended to get higher earners to contribute more to their university costs, and encourage them to pay off the loans early.
What does Plan 2 mean in practice?
It’s left millions of young workers facing three decades of crippling extra tax at 9%.
According to the Institute of Fiscal Studies, a typical graduate in their 20s or early 30s has to earn at least £66,000 a year before they start to see their debt shrink – and even then they’d be chipping away at the rate of £9 a month.
That’s a demoralising state of affairs for a whole generation.
And once you are earning over £50,000 you face an effective 51% marginal tax rate.
The system is also widely seen as unfair on middle-income earners.
Very high earners can make inroads into the loans quickly or pay them off in chunks.
Those with wealthy parents might pay the loan off immediately, or never bother taking them.
But for millions of workers on middle incomes – at the age when people often want to buy homes and/or start families – the extra 9% is weighing heavily on pay packets and morale.
Why are student loans in the news?
Rachel Reeves, the chancellor, plans to freeze the threshold above which Plan 2 graduates (in England) will repay 9% of their earnings – meaning that even more not-that-well-off people will be dragged into paying extra tax.
This April, that Plan 2 salary threshold will rise to £29,385, but in the November Budget, the chancellor announced that it will then stay frozen until 2030 – serving up a double helping of fiscal drag aimed squarely at middle-income strivers.
Since then, the issue has been put squarely on the political agenda, with several newspapers launching campaigns against the “tax on aspiration”.
In January, pundit Martin Lewis condemned the freeze as immoral and likened the government to loan sharks for reneging on their “contract” with young people.
The issue is not just a political time bomb, but arguably a giant state-sponsored mis-selling scandal, given that hardly any 18-year-olds understood the implications of the loans they were encouraged to take, says Claer Barrett in the Financial Times.
Meanwhile, the disincentives inherent in sky-high marginal tax rates will inevitably be a brake on UK growth and productivity.
What should happen?
The unfairness needs to be tackled, not least the gap between Plan 2 student loans and Plan 5 student loans – the Institute for Fiscal Studies projects that the top-earning half of 2022 freshers will pay an average of £20,100 more than if they had started university a year later.
This is not just an issue of fairness but of vital national interest, says Lara Williams on Bloomberg.
Student-loan debt is not the only reason more young Britons are emigrating, but it’s a factor – and a self-harming cap on motivation and ambition.
Campaigners call for a threshold freeze, a reform of interest rates so balances do not grow faster than repayments, and a reduction of extra tax rates from 9% to 5%.
Both these are “sensible demands”.
Going further, offering favourable student-loan terms – even debt forgiveness – to our most-needed occupations, such as doctors and nurses, could “help stem any impending brain drain and make up for stagnant wages”.
This is an issue that is only going to grow in salience.
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