A foreign education has almost become a rite of passage for an Indian upper middle-class family. In previous decades, it was unaffordable to most people. The few who went had to rely on scholarships. In more recent years loans and family savings are playing a larger role. Many young people also work to save up for their foreign degrees. In this article, we look at where you can invest your savings for a foreign education.
Start date less than five years away
In this case, you have less time to build up your savings and have to rely more on scholarships, parental funding and education loans.
The interest on education loan varies from about 10-12%. State Bank of India charges 10% on loans up to Rs 7.5 lakh and 10.75% on higher loans. It also offers a 0.5% discount to female students.
Axis Bank charges 10.5% to 12.5%. HDFC Bank charges anywhere between 9 to 14% with an average rate of 12.25%. You can use our education loan calculator to work out how much EMI you would have to pay.
|SBI||10 – 10.5%|
|HDFC Bank||9 – 14%|
|Axis Bank||10.5% – 12.5%|
The interest on an education loan is tax deductible under Section 80E of the Income Tax Act and this extends to loans taken for the spouse or children. In other words, you or your parents can get a tax deduction on the interest component of your education loan EMI.
The tax deduction extends for up to eight years from the year in which you start repaying the loan. The deduction is available for higher education (both graduate and post-graduate education) in both India and abroad.
If you don’t want to go down the education loan route or want to fund part of your education with savings, investing in mutual funds is a good option. A time horizon of less than five years means that equity funds should be avoided.
You can look at both short-term debt funds and income funds. These give returns of 7-9% annualized although this can fluctuate with market cycles.
Debt Mutual Funds offer 2-3% more than simple savings accounts in banks. Their returns are similar to fixed deposits but are more tax efficient because the returns in them (for the growth option) are taxed as capital gains.
Their returns are taxed as long-term capital gains if you hold the fund for at least three years, which means a tax of 20% and the benefit of indexation. Indexation factors inflation into your taxable gains and can reduce the effective rate of tax to below 20%. Even if you sell the funds within three years of purchase, no TDS is deducted from the sale proceeds giving you a small tax boost.
Unlike bank fixed deposits, debt funds do not have premature termination penalties. They can have exit loads but these typically are waived off after one year of holding.
One category of debt funds called liquid funds do not have any exit load at all. You can invest in these if your education starts less than a year from today. You can find out more about mutual funds here.
What about annual tax-saving deductions?
Some people give up their annual tax saving deduction under Section 80C because the investments available under Section 80C have lock-in periods ranging from three years (for ELSS Funds) to 15 years (for PPF). They figure that they will not be able to use this money to pay for their university fees, flight tickets or living expenses and hence pay the tax instead to build up liquid balances. However, this can be a major blunder if you are in the 20% or 30% tax bracket.
Earning more than Rs 5 lakh per annum puts you in the 20% bracket and more than Rs 10 lakh puts you in the 30% bracket. This means you automatically get a 20% – 30% boost on the amount you put into tax-saving investments.
You can get a loan against many of these instruments, three years after investing in them and utilize this amount for higher education. Unless you really need the money urgently, do not throw away your tax-saving deductions.
Start date more than five years away
In this scenario, you can consider investing in equity mutual funds. The long-run returns on these funds are around 12%. However, this is by no means are guaranteed and can fluctuate depending on market conditions. You can invest lump sums in them or start Systematic Investment Plans. Use our lump sum and SIP calculators to figure out how much you can accumulate with different investment levels and different rates of returns. Choose a multi-cap fund to save you the trouble and expense of switching between large caps and small caps. Equity mutual funds carry a 15% tax for holding periods less than one year and a 10% for longer holding periods, on their gains. In addition, you can also look at education loans as mentioned above.
Let’s take two examples.
Assume you need to accumulate 50 lakhs for your foreign education at the end of 3 years. How much do you need to save?
You will invest in a debt mutual fund due to your relatively short time horizon. Assuming a return of 7% on your SIP in a debt fund, you will need to put aside Rs 1.15 lakh per month. You can of course, take an education loan for half this amount. In this case, you need to put aside Rs 58,000 per month. In both cases, we have also assumed that you can increase your SIP by 5% per annum, due to salary increments.
Assume you need to accumulate Rs 1 crore for your foreign education at the end of 6 years. How much do you need to save?
In this case, you can invest in an equity fund. Assuming a return on 12% on your equity fund, you need to put aside Rs 83,000 per month. If you can get an education loan for half this amount, your monthly SIP amount can fall to Rs 42,000 only. We have once again assumed that you can hike your SIP by 5% per year due to salary increments. Do note that returns of equity funds are by no means guaranteed and are highly volatile.
There can be many permutations and combinations of these figures – your return rate, the time you have before you go abroad and your ability to increase your SIP. You can play around with different scenarios using our SIP calculator.