How safe is your child’s education fund?

Her equity investments have earned good returns and she is very bullish on the India story. Yet, Mumbai-based entrepreneur Teena Shah has started booking profits and shifting her money from equity funds to fixed deposits. “With just three years to go for my daughter’s college, I can’t afford to remain invested in equities,” she says.Financial planners would agree. However bullish you may be on the equity markets, if your financial goal is very near, say 2-3 years away, you should not be invested in volatile assets. A sudden downturn in the equity markets, such as the Covid-induced crash of March 2020, can make a big dent in your corpus and upset your planning. The higher returns from equity investments are not worth the risk.Shah can afford to take a breather because she started early and has already built a sizeable corpus of ₹2 crore. When her daughter was only six, she started an SIP (systematic investment plan) of ₹5,000 in a large-cap equity fund. Later, she added flexi-cap and small-cap funds to the portfolio. Small111237284The benefits of an early start cannot be stressed enough when you are saving for a long-term goal. The multiplier effect in the power of compounding comes from the investing time horizon. The longer the time horizon, the greater is the multiplier effect. If you delay investing, your corpus will be significantly smaller.Shah also made the smart move of increasing the SIP amount every year. “As my income increased and confidence also grew, I started investing more in equity funds,” she says. The monthly investment has increased from ₹5,000 in 2015 to ₹35,000 now.It’s only that the monthly investment is no longer flowing into equity funds, but in fixed deposits. “Stocks have the potential to give great returns in the long term, but greed should not make the investor lose sight of her goals,” says Shah.Experts say that when the goal is very near, the investment strategy should focus on capital protection, with no more than 10-15% in equities.Taking inflation into accountStock market volatility is not the only challenge faced by parents saving for their children’s education. Inflation is also a big problem, although it is not always visible. Education costs are rising at a fast clip of almost 10-12% per year. In fact, after healthcare, education is the fastest growing cost in the average household budget. Parents who have not taken inflation into account may end up falling short of the targeted amount.That’s what is worrying Maria and Chitwan Dogra. The Noida-based couple has been investing in safe fixed-income options for their daughter’s education. However, their perspective changed after they met a financial planner. He told them that the 7% annual return earned on their savings would not be able to keep pace with the 10% yearly increase in the goal target. In 13 years, when their daughter is ready for college, the required amount would have risen from ₹1 crore to nearly ₹3.5 crore. Small111236393Their financial planner has advised the Dogras to start investing in growth assets. He says the child education goal is 13 years away, so the asset allocation of the investment portfolio should be at least 80% in equities and only 20% in fixed income. It may not be possible to go from zero to 80% immediately, but the Dogras are now going to start SIPs in equity and hybrid funds so that they have enough for their daughter’s college expenses.They have also been advised to review the progress of the investment plan and increase the SIP amount every year in line with the increase in salaries. Any windfall gain or maturing fixed deposits should also be ploughed back into the equity portfolio.Foreign education will need moreParents planning foreign education for their children have to be extra careful. They also need to account for the depreciation of the rupee against the foreign currency. The US dollar has risen about 20% against the rupee in the past five years, averaging an appreciation of more than 3.5% per year. So, along with the rise in the cost of education in the foreign university, the rupee depreciation will push up the required target.That’s something Richa Malhotra has carefully considered in her calculations. The New Delhi-based finance professional is saving for her children’s foreign education. “The cost of foreign education is around ₹70 lakh right now. I have assumed a 14% annual increase in the cost,” she says. Accordingly, the target works out to around ₹1.5 crore for her son in six years and ₹2.5 crore for her daughter in 12 years.Her planning doesn’t stop here though. As a chartered accountant and head of corporate sales at TaxSpanner.com, Malhotra understands the tax benefits available on education loans. Under Section 80E, the entire interest paid on an education loan can be claimed as tax deduction. Accordingly, she plans to go for education loans to fund her children’s foreign studies.It would be a smart move because the savings in tax can drastically bring down the effective cost of loan. The higher the taxable income of the individual, the bigger the tax benefit. For someone in the 30% tax bracket, a loan taken at 14% per annum effectively costs 9.63% a year. Small111236404This is very cheap considering the prevailing high interest rates, wherein personal loans are available at 18-24%. Also, unlike a home loan, where the tax deduction for self-occupied houses is limited to ₹2 lakh in a year, there is no limit to the tax deduction on an education loan. However, the interest deduction is available for a maximum of eight years. For instance, if you take a loan in 2024 and start repaying it in 2026, the interest deduction will not be allowed after 2034.A taxpayer can avail of tax deduction only if the loan has been taken for himself, spouse or children. The interest paid on loans taken for siblings or other relatives is not eligible for income-tax deduction.Lenders usually insist on a collateral, which could be immoveable property, National Savings Certificate, fixed deposits, bonds and endowment insurance policies. Also, the loan should be from a bank or financial institution notified for the purpose. No tax deduction is available if the loan has been taken from a private source or an overseas lender.For Malhotra and her husband, the benefits of the education loan go beyond numbers. She sees it as a stepping stone that will teach her children financial discipline. “If the child is a co-borrower for loan, the repayment burden will make him financially responsible in his early working years,” she says.Education loans usually come with an EMI holiday and the repayment can be deferred for up to 1-2 years till the student has taken a job. “The loan EMI will act as a deterrent and force him to be frugal in his spending,” adds Malhotra.Seven options to build an education corpusBank depositsFixed and recurring deposits give low, but assured, returns. These have become more attractive after the change in tax rules for non-equity funds. Invest in these for certainty of returns and stability of portfolio.Return: 7-7.5%Tenure: 1-10 yearsTaxability: Interest income is fully taxablePublic Provident FundThe PPF rate has come down in the past two years, mirroring the decline in bond yields. There is also an investment cap of ₹1.5 lakh in a year. However, assured return as well as tax-free interest and maturity make it attractive.Return: 7.1%Tenure: 15 years from inceptionTaxability: Interest, maturity are tax-freeSukanya Samriddhi YojanaLike the PPF, this scheme also offers tax-free interest and maturity, and there’s an annual cap of ₹1.5 lakh on the investment. However, it is open only to girls below 10 years. Use it to build a tax-free corpus for your daughter’s education.Return: 8.2%Tenure: 21 years, or till girl turns 18Taxability: Interest, maturity are tax-freeUlipsLike mutual funds, these insurance plans offer market-linked returns, but with the added benefit that switching between funds has no tax implication.Return: Market-linkedTenure: Minimum 5 yearsTaxability: Corpus is tax-free if total annual premium of all Ulips (bought after February 1, 2021) is less than ₹2.5 lakhStocksInvesting in bluechip stocks has proved very rewarding for investors. However, investing in shares without adequate research and knowledge of trading rules can be risky. The average investor is better off investing via mutual funds.Return: Nifty 14.1% (past five years)Taxability: Long-term capital gains of up to ₹1 lakh in a year are tax-free. Beyond that, gains are taxed at 10%. Short-term gains taxed at 15%Equity fundsDiversified equity funds are an easy and convenient way to invest in stocks. Diversified equity funds cover all segments and sectors of the market. If investing for more than 5-6 years, diversified equity funds are your best bet.Return: 16-28% (past five years)Taxability: Long-term capital gains of up to ₹1 lakh in a year are tax-free. Beyond that, gains are taxed at 10%. Short-term gains taxed at 15%Debt-oriented hybrid fundsThese funds follow a conservative investment strategy, allocating only 10-25% of their corpus to equities and putting the rest in bonds and other debt instruments. This category gives relatively stable returns, so don’t expect fireworks.Return: 9.5% (past five years)Taxability: Gains are added to income and taxed at the marginal rate