Funding child education: Take loan for tax benefits

While everybody wants their child to have a good education, Indian parents are especially intent on achieving this goal. So focused are they that they are willing to scrounge on basic indulgences to save for their kids' college fees.

The problem is that in their efforts to fulfil the needs of the child, they sometimes sacrifice more than they should. They dip into their retirement funds to pay for the education. This is a dangerous strategy because it leaves them financially vulnerable in their sunset years.

We all know that the cost of higher education is rising at a fast pace. Unless you foresaw this trend 10-12 years ago and started investing aggressively for this goal, your savings alone might not be enough to fund your child's higher education.

Instead of withdrawing from your Provident Fund or PPF, it's better to bridge the gap with an education loan. It is not only tax-efficient, but helps inculcate financial discipline in the child by making him responsible in his early working years.

It may be argued that taking a loan in these times of high interest rates is not a prudent strategy. You will be paying 12-14% on the loan, while your investments earn only 8-8.5%. However, keep in mind that any loan taken to pay for the education of your child is eligible for income tax benefits.

Under Section 80E, the entire interest paid on the loan is eligible for tax deduction. The savings in tax can drastically bring down the effective cost of the loan (see table).

The higher the taxable income of the individual, the bigger the tax benefit. For someone in the highest 30.9% tax bracket, a loan taken at 12% per annum effectively costs 8.71% a year. This is very cheap considering today's regime of high interest rates, wherein personal loans are available at 18-20%.

Also, unlike a home loan, where the tax deduction for self-occupied houses is limited to Rs 1.5 lakh in a year, there is no limit to the tax deduction on an education loan. However, keep in mind that most lenders don't give education loans of more than Rs 10 lakh, so a limit is set by default.

An education loan will also help in making your child financially responsible in his early working years. Education loans usually come with an EMI holiday and the repayment can be deferred for up to 1-2 year till the student has taken a job. In the initial years, when the financial responsibilities are few, young people tend to be extravagant.

Source:-Economics Times 23 May, 2011