Just a disclaimer here – “I am not a proponent of taking out loan in any form or for any purpose”. But the purpose of this article is to give some light to the readers on how tax deductions that come with education loan repayments, which makes these loans somewhat attractive.
Higher studies are an expensive endeavor, particularly if your child chooses to take a professional degree or to study overseas. It is also one of the most important financial goals for most parents, and many begin investing shortly after their children’s birth. These investments (be it real estate, equities, mutual funds, or fixed deposits) are often terminated when their children join the college or university.
No matter whether you have a large sum of money to cover your child’s higher education, an education loan can help you manage your finances more effectively. Students can acquire an education loan, which they can pay back after they get a job. However, rather than putting pressure on their children with loans, many parents choose to self-finance this huge expense with their existing wealth. Financial experts, however, warn against this tendency, claiming that educational loans benefit both from a returns perspective and also from a taxation perspective. We will try to discuss these in detail in this blog-post.
But you have to be careful here as to what you do with your corpus. Your corpus should be deployed such that it would fetch you returns that would negate what you have to pay as the interest on the education loan. Merely keeping the corpus in a savings account or in a bank fixed deposit is not a good idea, as it will lead to low returns than the interest on education loan and also it will cost you tax on the interest income earned from the fixed deposits or from the savings accounts returns. So, it should be deployed in the financial market, with some good exposure to equity for better returns that could beat the interest rate of the education loan.
If you use your money wisely, your corpus can yield higher returns than the entire interest expense on an education loan. In addition to steering clear of long-term capital gains tax on withdrawals from your amassed corpus, your stock/MF portfolio will keep compounding at a healthier rate than the interest that you pay for an education loan.
The Tax deduction part:
Let’s look at the tax benefits of an education loan. The annual interest payment for the student loan qualifies you for a tax deduction. Section 80E of the Income Tax Act allows for an unlimited tax deduction against the interest component of education loans for a maximum of eight years from the start of repayment. However, you have to realize here that the principal payment doesn’t give any tax benefit. Tax advantages are only available for the interest portion.
To demonstrate this, consider the hypothetical situation of Karthik, who is in the 30% income tax bracket and requires Rs. 1 crore to pay his son’s further education. He may sell his investment assets for this reason. However, he decides to take out an 8-year education loan to lower his tax obligation. Karthik is going to repay Rs. 1.5 crore (1 crore principal + 50 lakhs interest cost) on the education loan over the course of 8 years. However, he may save Rs. 15.47 lakh in total taxes over the course of 8 years. At the same time, his stock/mutual fund portfolio would expand. For example, if you invest the same Rs. 1 crore (principal amount necessary for higher studies fees) in mutual funds with a measly 10% return, your 1 crore corpus will more than double to Rs. 2.2 crore at the end of the 8-year debt payback. It may be noted that the interest component is higher during the initial years of the repayments and then gradually reduces as the principal is paid back. In fact, you would have earned Rs. 1.2 crore in returns while paying just Rs. 35.5 lakh in interest costs, resulting in a net asset increase of Rs. 84.5 lakhs if you decided to take out an education loan.
It is important to highlight here that loan repayments should be paid by the parents. The person who is paying the EMIs will be able to claim a Section 80-E tax deduction. It is recommended that parents take advantage of this tax incentive because their tax burden will be larger than that of their kid who has recently begun working.
Know your risk-appetite:
Though it is common advice in the personal financial industry to avoid taking on debt, it is equally important to understand that certain loans are beneficial. Some personal financial professionals in the marketplace say that it is best to stay away from all debts except for housing and education loans. For these loans, the repayment mechanism and its tax benefits are designed to some extent in favour of the person who borrows.
However, your own personal risk appetite comes first. If you believe you have other ambitions in your life, such as establishing your own business or incurring other costs with your accumulated funds, it is usually recommended to pay back your debts first before embarking on any ventures that involve risk such as launching a business or start-up.
Consider other ancillary costs while studying:
Parents must also consider supplementary charges, which include their children’s living expenses while studying overseas. To have money on hand for your child’s additional costs while they pursue higher studies, you may choose to apply for an education loan, so that the additional costs are taken care by your money and the tuition fee is paid via the education loan.
One must have sufficient funds in their bank account to cover additional educational expenditures such as accommodation, food, books, travel, gadgets, and so on. This is one of the reasons why we can explore the option to take an education loan for the tuition fee instead of spending it all from your savings.
Tax Collected at Source (TCS):
This section of this blog-post is not relevant to people who are making applications for higher education in India. However, people planning to study abroad must consider the Tax Collected at Source (TCS). As we all know, beginning October 1, 2023, every international transaction in excess of Rs. 7 lakh per fiscal year per individual would be subject to a 20% TCS, with the notable exception of education and medical payments. TCS will be levied on education remittances exceeding 7 lakh at a rate of 0.5% (if funded by an education loan) or 5% (if the education is self-funded).
So, if you transfer 1 crore to a foreign university by self-funding the cost of education and if there is no other foreign money transfer, the bank will collect 5% tax on Rs. 0.93 crore (which comes to Rs. 4.65 lakh vs. Rs. 46,500 when you send the money as an education loan due to the 0.5% remittance amount). As a result, if you are pursuing a self-financed degree, you need keep an extra Rs. 4.65 lakh on hand when you transfer the money to the overseas university. Because this is an advance tax, you can still claim it as a refund when you file your income tax return. But taking an education loan makes you avoid this amount outgo and will also avoid the hassle of you getting the refund of this TCS at the time of income tax return filing.
Avoiding Moratorium:
When it comes to any debt repayment, you may sometimes hear the phrase ‘Moratorium’. A moratorium is a repayment holiday during which the borrower is not required to repay the debt. Banks typically provide students with a loan payback holiday while they study. This moratorium period spans for the period of the course and can be extended for approximately 12 months after the course. Students are not required to pay EMIs during this moratorium, although interest is computed immediately after the loan is given and is accumulated along with the principal amount.
According to the Indian Banks’ Association (IBA), banks are bound to charge simple interest on loan amounts (up to Rs 20 lakh for overseas education loans) during the moratorium period. This amount is added to the principal, and the EMI is computed appropriately when the repayment period begins. But some private banks may charge compound interest throughout this period. So, we need to be careful on this part, and it is better for us to pay off the interest component during the moratorium period to avoid further interest payments caused by the compounding impact of interest cost buildup. Those who service the interest component during the moratorium period are eligible for a 1% interest discount under the IBA provisions. However, it is preferable to avoid moratoriums altogether, as they raise your overall interest expense.
