Friday, 22 June 2012

Tax time - Should I repay my HELP debt early?

In Australia, we are lucky enough to have a system where everyone can afford a higher education.  The government will fund undergraduate education for every Australian resident under the Higher Education Loan Programme.

The programme is very simple and is outlined below
  • While you are at university the government funds your tuition fees
  • You incur a debt to the government
  • The debt is indexed to inflation (i.e. it is the cheapest debt you will ever get)
  • When you earn over a threshold amount ($47,195 for the 2011 / 2012 tax year) you then have to start paying it back (gets taken out of your income like income tax)
  • The rate of repayment varies depending on your income - see table below for the 2011 / 2012 repayment thresholds

Repayment rate (% of repayment income)
Below $47,196Nil
$87,650 and above8.0%

This repayment rate is compulsory.  The question arises of when should you repay your HELP debt early?

At first glance there seems little incentive to repay your HELP debt early.  The implied interest rate (inflation) is the cheapest debt you will ever get so you should really use your cash for other things (which you would normally borrow money for) such as investing or buying a house etc.

However the programme incentivises you to repay your debt early by providing discounts for early repayment.  After 31 December 2011 this incentive dropped to 5% for all amounts paid above $500. 
  • The benefit is therefore 5% + inflation (i.e. the amount your debt would have increased by)
  • Assuming inflation of ~2.5% this means that by paying early you get a total return of 7.5% guaranteed on your cash which is nothing to sneeze at but not spectacular either (at the moment you can get that as a dividend return on high yielding Australian bank shares)
There is one situation however where you should always repay your debt early.  If you are due to finish repaying your HELP debt in the current year through compuslory repayments (i.e. in the table listed above) you should pay your debt off before the tax office calculates it.  I realise this sounds a little confusing so let me outline what I mean
  • The tax office calculates your HELP obligation when you submit your tax returns (about July / August)
  • It does not know how much your employer has been taking out of your paycheck until this point
  • Assume you have $5,000 of HECS left on your debt and your employer has taken this out of your pay packet and already sent it to the tax office - they do not know this yet
  • In June (before the end of the financial year) you can pay (5000 / 1.05) = $4,762 to the tax office to satisfy your HELP debt
  • In July / August when you submit your tax return the tax office will realise that you have paid off your debt but your company has sent them an extra $5,000 through the year and so will return this to you
  • You get the extra benefit of the $238
    • This is actually a pretty decent return on cash outlayed
    • $238 / $4762 = 5% over 2 months
    • 30% annualised return
Note that the above example only works in the year where you are due to finish repaying your HELP debt.  In other years your contribution will just further reduce your HELP balance and you will only get a 7.5% annualised return.

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