Loan, a grade better than withdrawing PF to fund education

Emptying out your provident fund may not be the wisest thing to do in order to finance your child's education.

With interest rates on the rise, are you worried that payouts for your child's education loan would take a toll on your financials? Your concerns may be unwarranted for , as availing an education loan is a more convenient and tax efficient option as compared to withdrawing from your Employee Provident Fund (EPF) or other sources.

Although it appears that meeting education needs through our own funding is better rather than borrowing, a finer crunching numbers gives a different picture altogether.

In a recent visit to the EPF office, one came across individuals seeking procedure for withdrawal/advances from their provident fund accumulation to meet the educational needs of their son/daughter.

Although one is allowed to withdraw from the EPF account, withdrawal cannot be more than three times for education and marriage . Due to this limitation, you may find it difficult to meet your child's entire education expense through your EPF account.

The better option

If you avail an education loan , for the first four years from the time loan is availed one is required to pay only the interest.

Repayment of principal will commence only one year after completion of your child's course or six months after securing a job, whichever is earlier.

For instance, If you wish to avail an education loan of Rs 1 lakh for each of four academic years, starting 2011-12, during the first four years, assuming the interest outgo of 12 per cent, you will be paying an interest of Rs 1.2 lakh. After one year, you will be repaying interest and principal.

For the intervening period (fifth year you will pay an interest of Rs 48,000). If you wish to repay the loan in five years post education, in all, you would be repaying interest and principal to the tune of Rs 7, 01,886 (for a loan of Rs 4 lakh).

Individuals availing loans should bear in mind that tax deduction benefit is available for a total of eight years or till the principal and interest amount have been repaid, whichever is earlier.

If your loan tenure exceeds eight years, no deductions can be claimed under Section 80E beyond that period. The benefit under this Section is over and above the tax benefits Section 80 C.

Let us consider two scenarios: one when you are repaying your loan in 10 years.

Here you would have to repay Rs 7, 01,886 for those in the tax bracket of 20 per cent, after availing tax benefit on the interest payment for eight years, provided you borrow at 12 per cent.

In the second scenario, if you wish to repay your loan within eight years, the total repayment paid in this case will be Rs 6.46 lakh.

Even if you have a surplus every month, it is better to spread out the repayments in such a way that your final settlement is in the eighth year to enjoy the tax deduction.

If the loan is borrowed for girl student the outgo will go down further due to interest rate concession.

Stay away from EPF

Assume that you are withdraw Rs 1 lakh for the next three years. With the current interest rate of 8.5 per cent, the balance in your EPF on account of this withdrawal at the end of 10 years would be short by Rs 6.3 lakh.

Additionally, to meet the last year's education needs, if one avails a Rs 1 lakh loan from a bank, you would have to repay Rs 1.33 lakh at the end of fifth year. Under this option, after adjusting for the tax benefits, your total outgo would be Rs 7.4 lakh compared to Rs 6.46 lakh in the case of education loan availed for eight years.

Also, since you are meeting the education needs through internal accrual, you lose tax benefits to the tune of Rs 50,000. The overall impact would be Rs 7.9 lakh.

Even though the EPF is accumulated to meet retirement needs, individuals can withdraw from their account for the admissible purposes.

However, while doing so they should take cognisance of the opportunities lost and tax benefits before withdrawing money from this account. The interest received is tax free.

As EPF interest rate is compounded compared to simple interest calculated in the case of education loans (four years), interest accrued in your account will outpace the interest paid for the loan.

Hence, for education purpose, take a loan and enjoy the benefits.

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