Money
How tax deductions make education loans attractive
Summary
- Section 80E of Income Tax Act allows you to claim tax deduction on interest for up to 8 years.
Higher education is a costly affair, especially if your child decides to pursue a professional course or opts to study abroad. It is also one of the key financial goals of most parents, many of who start investing for this soon after the births of their children. Such investments, made either in real estate, stocks, mutual funds or fixed deposits, are usually liquidated at the time of college admissions.
To be sure, students can avail of an education loan which they can repay later on getting a job. Yet, many parents tend to self-finance this major expense from their investments accumulated thus far, rather than burdening their children with loans. Experts, however, caution against this trend and say that education loans help from a returns and taxation point of view.
“If you can deploy your savings astutely, your corpus can give you better returns than the total interest outgo on an education loan. Moreover, the annual interest payment makes you eligible for tax deduction," says Anurag Jain, co-founder and partner at ByTheBook Consulting LLP .
That is exactly what Delhi-based Ankit Mehra (38) did. He was 28 years old when he decided to pursue an MBA from IESE Business School, Barcelona, in August 2013 and needed more than ₹50 lakh for his studies. Mehra had a rich stock portfolio, besides a property in Delhi-NCR that he could have sold off to pay for his studies. “I opted for an education loan because I felt that my corpus would fetch me returns that would negate what I had to pay as the interest on the education loan," says Mehra, who is now co-founder and CEO of GyanDhan, an education financing marketplace.
Some parents, though, want their children to learn financial discipline while doing their studies. Kulwant Singh Kalra, for example, self-financed the first-year course fee for his son who is studying culinary management in Canada. “The work culture in Canada allows students to take up part-time jobs for a few hours every week. I want my son to earn and save for his education fee next year onwards. I am always there to chip in if there is an issue but he must take on that financial responsibility right away," he says.
No cap on tax deduction
Experts say opting for an education loan has other advantages. For instance, section 80E of Income Tax Act allows you to claim tax deduction on the interest component of the education loan EMI without any upper limit. Moreover, one can claim it for a maximum of eight financial years after the repayment begins. Notably, principal payment doesn’t offer any tax relief.
To illustrate this better, let’s take the hypothetical case of Ravi, who is in the 30% income tax slab rate and needs ₹1 crore to fund the higher education of his child. He can liquidate his stock portfolio for this purpose. However, he chooses to take an education loan for a tenure of 8 years to reduce his tax liability. Ravi will pay ₹51.57 lakh as interest in the course of 8 years on the education loan (see graphic). However, he can save ₹15.47 lakh in taxes cumulatively during this period. Meanwhile, his ₹1 crore stock portfolio, assuming a CAGR of 10%, would grow to ₹2.14 crore.
Financial experts say it is better if the loan instalments are paid by the parents. The person paying the EMIs will be eligible to claim section 80-E tax deduction. “We advise our clients that parents should avail of this benefit because their tax liability will be higher than their child who has just started the job," Jain says.
Know your risk-appetite
Though financial experts ask their clients to avoid taking on debt, they also let you know that some loans are productive. “I tell my clients to avoid all debts except the home and education loans. The repayment is structured in a way that it benefits the borrower," says Jain.
However, risk-appetite comes first. Thus, Mehra of GyanDhan, decided to pay off his education loan first before he decided to launch his startup. “I felt the need to minimize my risk exposure in other areas. I started selling off my investments in the stock market and finalized the sale of my property in Delhi-NCR. Once I moved back to India in May 2015, I consolidated all my finances, and paid off the entire loan in one go, says Mehra.
Consider ancillary costs
Parents also need to take into account ancillary costs that take care of living expenses of their wards who study abroad. Kumar Vishal Singh, a resident of Noida, says he recently secured admission for his son Krish Singh to the four-year B.Tech (Hons) course in Mechatronics from Sydney University, and wanted to part-pay the ₹1 crore fees. However, he needed to maintain at least ₹30 lakh in his bank account for his son’s visa process. He then secured a ₹1.2 crore loan from a private sector bank at an interest rate of 9.25%. The monthly EMIs came in at ₹1.44 lakh. “One needs to have enough funds in the bank account that can take care of other education expenses such as hostel, food, books and travel. This is why I preferred to hold on to my savings and take an education loan. Moreover, loan EMIs help me claim deductions that reduces my tax liability," says Singh.
Those opting to study abroad need to take into consideration the tax collected at source (TCS), effective 1 October. Any foreign transaction beyond a threshold of ₹7 lakh per financial year per individual will attract TCS at the rate of 20%, with an exception in education and medical transactions. In case of education, TCS shall be applicable beyond ₹7 lakh at 0.5% (if remittance for education is financed by education loan) or 5% (in case it is self-financed). So, if you are sending ₹1 crore to a foreign university, and assuming there is no other foreign remittance, the bank will collect tax on ₹93 lakh (see graphic). Since this is advance tax, you can get it back as a refund when you file your income tax return.
The moratorium
Typically, banks offer students a loan repayment holiday while they are studying, which is called moratorium period. It lasts for the duration of the course and is extended by about 12 months afterwards. Students do not have to pay EMIs during this moratorium, but interest is calculated right after the loan is disbursed. “As per Model Education Loan Scheme by the Indian Banks’ Association (IBA), banks are required to levy simple interest on the loan amount (if the foreign education loan amount is up to ₹20 lakh) during moratorium period. This amount gets added to the principal and EMI is calculated accordingly when the repayment starts," says Adhil Shetty, CEO and co-founder of BankBazaar. Some private banks may levy compound interest during this period. Financial planners say that borrowers should pay off the interest portion during the moratorium period to avoid additional interest outflows. “Those who service the interest component during moratorium period can get 1% interest concession as per IBA provision," says Shetty.
