Overpay your student loan, or use a pension or ISA instead?
“Overpay or invest?” is really several questions. Once you break them apart, there’s a sensible order in which to think about them.
1. A workplace pension match usually comes first
If your employer will add money to your pension when you pay in, that’s usually the best return available, because it’s an immediate increase on what you put in. Tax relief on pension contributions adds to that. Neither an overpayment nor an ISA competes with it.
Pensions are locked away until later in life, so it isn’t the right home for money you may need soon. But if you aren’t getting a match you’re entitled to, look at that before either of the options below.
2. Then compare your loan with investing
With an overpayment, the “return” is the interest rate on your loan, and only if you’d otherwise repay in full. It’s certain, and it’s tax-free in effect, because it just reduces what you owe.
With a Stocks and Shares ISA the money can grow free of tax, up to the annual allowance (check gov.uk for the current limit). The return isn’t guaranteed and can be negative in any given year, but over long periods diversified investments have often earned more than student loan interest rates, but not in every period, and you can lose money.
| Overpaying | Investing in an ISA | |
|---|---|---|
| Return | Known: your loan’s interest rate | Unknown: could be higher or lower |
| Risk | None | You can lose money |
| Access to the money | Gone once paid | Normally available if you need it |
| Only worthwhile if | You’d repay the loan in full anyway | You keep the money invested |
The last row of each column is the important one. If the loan will be cancelled before you clear it, the overpayment has no return at all, and the comparison is over. See when does my student loan get written off?
3. Access matters
An ISA can usually be withdrawn from if you need to. An overpayment can’t. Anyone without a few months of expenses in easy-access savings should think about that before either option.
Does a pension change your student loan payments?
It can. Student loan repayments are based on your income as your employer reports it (GOV.UK describes income as what you earn before tax and other deductions). Some pension arrangements, such as salary sacrifice, can change the pay your employer reports, which may change your repayments. Ask your payroll team how yours works. This is worth knowing but is not a reason to pick a pension on its own.
Putting it together
A reasonable order to consider is:
- An emergency fund
- Any pension match on offer
- Then either overpaying the loan (if you’d repay it in full) or investing, according to the interest rate, your time horizon and how you feel about risk
Use the calculator to compare the last two using your own numbers, and see should I overpay my student loan? for the logic behind it.
This is general information, not personal financial advice, and tax rules and allowances change. See the disclaimer, and consider independent advice for a significant decision.