Every parent wants the best education for their kid. However, this tends to be an expensive affair. This is why you must plan for your kid’s education well in advance.
Anand, 15, is an aspiring software engineer. He has always wanted to join one of the Indian Institutes of Technology (IIT). He is taking coaching classes to crack the exam that will help him get into an IIT. In case he doesn’t get through, Anand will be forced to join a private engineering college which might charge double or even treble of what the IITs charge.
So, naturally his father, Mr. Karthik is pretty worried. Mr. Karthik who is 45 years old, is working as a system administrator in a tech firm. Mr. Karthik was always interested in the stock market and had invested all the money for his son’s education in stocks. With some of the stocks not doing as well as expected, Mr. Karthik might be short of funds for his son’s education if Anand doesn’t get into an IIT. He might have to opt for an Education Loan.
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This is the typical mistake many investors tend to make when it comes to saving for a goal. They either do away with safe instruments like Fixed Deposits or in the hope of getting higher returns, don’t move their investments to safe avenues as they inch closer to their goals. Ideally, if you are investing in risky assets for long-term goals, it is important to move them totally to fixed-income instruments for the last three years. That is, three years before reaching the goal, you should have moved all your money to safer avenues. This is to keep the capital safe so that you can use the money to meet your goal. So, unlike Mr. Karthik, you should make a plan for your child’s education and move your money to safer avenues as your child gets ready to go to college.
Since education is a long-term goal, you can consider investing in equity instruments such as stocks and Mutual Funds. But you must have a good mix of equity and fixed-income so that your returns remain stable. Ideally, for a 15-year goal, in the first five years, you can have equity and debt in the ratio of 80:20, that is, 80% in equities and 20% in debt. In the next five years, the ratio should be 60:40. In the last five years, you should gradually move all your money to 100% debt. For tax breaks, you can even invest in Equity Linked Savings Schemes (ELSS).
Now, the question is which are the best fixed-income investments to look at? For your kid’s education, you can consider the National Savings Certificate (NSC), the Public Provident Fund (PPF), bank Fixed Deposits and debt Mutual Funds.
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The Roll-over Method
NSC being a sovereign investment is pretty safe. The current interest rate is 8.1% and the tenure being five years. The investment will give you tax benefits under Section 80C of the Income Tax Act. This is an ideal investment for long-term goals. The best way to invest in NSC is to match your maturity amount with the time of your goal. This means that your investments should be made in such a way that they mature when your kid has to go to college. In case, there are more years left for you to reach your goal, you can roll over the investment until you reach the goal.
Take the case of Mr. Roy. Mr. Roy is a 40-year-old and is a financial professional in Delhi. Mr. Roy invests in NSC on a recurring basis every five years. He says that the tax rebate for the investment as well as the interest is very useful for him and he also gets to save for his kid’s education.
Here’s how you could also do the same thing as Mr. Roy. Suppose your child’s education is 15 years away and you invest Rs. 1,00,000 in the five-year NSC. You will receive Rs. 1,48,738 in 2021. You can reinvest this in an NSC again for the next five years. You need to keep reinvesting the same until you need the money for your kid’s education. This way, you will receive Rs. 3,34,660 in 2031 assuming the interest rate remains the same.
This method will not only give you liquidity, it will also give you a chance to review the investment when it matures. You can invest the money in other avenues if they are giving better returns. Locking in your money for a longer tenure will deprive you of liquidity and you cannot reinvest money in instruments giving better returns.
The same method can be applied to Government securities. You can use one-year, two-year or three-year bonds for rolling over. As the investments mature, you can choose better investments that will give you higher returns. This method will give you a good lump sum when your child is ready for their higher education.
The Income Method
The other method is to create an income stream so that you can meet your kid’s education expenses on a periodic basis. Expenses such as tuition fees and hostel fees might be on a term or quarterly basis. Investing in instruments that give you regular income can help meet these periodic expenses. You can do this by a method called ‘laddering’. Laddering is a process where you invest a fixed amount of money in a fixed-income instrument every month, quarter, or year. You can use the maturity proceeds to meet your goal.
Let’s consider an example to understand the concept better. Suppose your child’s education is six years away, you can choose to invest lump sums in bank Fixed deposit with tenures of six years, five years, four years and three years. This way, you can get money in the first year your child goes to college, then in the second year of education, then in the third and fourth years respectively. This way your money remains invested, is safe, and you also have access to money when you need it. You can use the maturity proceeds of the Fixed Deposits to pay your child’s tuition or hostel fees.
When you use the laddering method, you need not invest the entire amount in one go. This protects your money and allows you to review your investments as you go along. Just like in case of the roll-over method, in laddering too, you can use a mix of Fixed Deposits, bonds, NSC and other fixed-income instruments. This will, of course, be based on the returns that you get at that point in time.
The Income Method
The other method is to create an income stream so that you can meet your kid’s education expenses on a periodic basis. Expenses such as tuition fees and hostel fees might be on term or quarterly basis. Investing in instruments that give you a regular income can help meet these periodic expenses. You can do this by a method called ‘laddering’. Laddering is a process where you invest a fixed amount of money in a fixed-income instrument every month, quarter or year. You can use the maturity proceeds for meeting your goal.
Let’s consider an example to understand the concept better. Suppose your child’s education is 6 years away, you can choose to invest lump sums in bank Fixed deposit with tenures of 6 years, 5 years, 4 years and 3 years. This way, you can get money in the first year your child goes to college, then in the second year of education, the in the third and fourth years respectively. This way your money remains invested, safe and you also get money when you need it.
You could use the maturity proceeds of the Fixed Deposits to pay your child’s tuition or hostel fees. When you do laddering, you need not invest the entire amount in one go. This protects your money and allows you to review your investments as you go along. Just like in case of a roll-over, in laddering too, you can use a mix of Fixed Deposits, bonds, NSC and other fixed-income instruments. This will, of course, be based on the returns that will provide you with, at that point in time.
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The Stay Put Method
If you think the roll-over and the laddering methods are a hassle, you can consider investing in long-term fixed-income instruments like PPF, tax-free bonds or infrastructure bonds issued by public sector companies. These instruments not only gives you safety of capital, they can also give you tax advantages. As you know, the PPF comes under the EEE status wherein the amount invested, the interest earned as well as the maturity amount are tax-free. This is an ideal investment especially for those in the highest tax bracket.
PPF and NSC are the right investments for those in the higher tax slabs of 30% and 20%.
Infrastructure bonds can be looked at by those in the lower tax slabs as the interest from these instruments will be taxed at a lower rate (as per your tax slab).
You could also look at investing in tax-free bonds. Note that income from these bonds is also free from tax. But remember that these bonds have low liquidity and you need to hold them until maturity. Even though these bonds are listed on stock exchanges, trading in them is limited. So, selling them before maturity will be tough.
However, the Government bond market is highly liquid. If you are investing in Government bonds, exiting them will be easier than exiting from tax-free or infrastructure bonds. You can invest in Government securities through your demat account.
The Foreign Method
Some of you might be Non-Resident Indians (NRIs) or your child might want to study abroad. In that case, your strategy should be a little different. You could consider investing in foreign Government bonds.
Take the case of Mr. Krishna who is a Private Equity investor in Chennai. Mr. Krishna has a daughter and a son who are teenagers and want to study abroad. Since funds for their education will be required in foreign currency, Mr. Krishna has invested in foreign Government bonds. This is the way parents can ensure that funds in the desired currency are available. Also, it is easier to forecast tuition, hostel and other expenses in foreign currency. Estimating them in Indian rupees could lead to errors due to conversion. Like Mr. Krishna, you can also invest in foreign Government bonds. This facility is offered by high-end broking firms. If you are a resident Indian, you will need to pay tax for the income earned on foreign bonds, only in India.
If you are not the kind to venture into anything foreign, you can consider opening an Indian account in foreign currency. This account is known as the Resident Foreign Currency (RFC) account. It is available in different foreign currencies like USD, GBP, EUR, JPY and CAD. Using this account, you can transfer funds and also receive funds from abroad. This account ensures that you don’t need to worry about fluctuations in exchange rates. Also, banks offer preferential rates to RFC account holders in case they want to convert the foreign currency into Indian rupees. The best part? There is no minimum balance requirement for this account. This means that you can freely transfer the entire amount in the RFC account without fear of withdrawal penalties.
Additional Reading: Is Financially Supporting Your Earning Child A Healthy Practice?
RFC account in a nutshell
- This is a savings account is maintained in foreign currency such as US dollars and British pounds.
- With this account, there is no fear of exchange rate fluctuations as there is no conversion.
- Banks provide you with net banking facility for easy transfers.
- In case you need to convert your currency, you get preferential rates for this account.
- Most banks do not require you to maintain a minimum balance for this account.
However, note that interest rates for foreign currencies will be much lower than those available for Indian rupee deposits. So, a better strategy will be to shift your money to a foreign currency account a year or six months before the funds are actually needed. For long-term goals, making a higher allocation in foreign currency can expose you to foreign exchange risks. It is best to always take the advice of a currency expert before you convert Indian rupees to foreign currency.
It is important that you create a study plan for your child as soon as you can. You can revise it as they grow and as their aspirations change. You also need to have a plan in place once your kids have decided what course they will take. Here are a few sample plans that you can consider.
If your kid is planning to go abroad for higher education:
- Open a Resident Foreign Currency (RFC) account to freely transfer funds to your kid residing abroad. This is a savings account maintained in foreign currencies.
- Shift your money to the RFC account by converting your money to foreign currency. This can be done six months before the money will actually be needed.
- Always take the advice of a currency expert before converting your money to foreign currency. This will help you save a ton which could otherwise be lost due to currency fluctuations.
- Look at investing in foreign government bonds after your kids start studying there.
- You can ask them to look for part-time jobs to supplement their living expenses.
If your kids are going to study in India:
- Consider rolling over five-year NSCs to create lump sums.
- You could also roll over bonds and FDs for longer tenures.
- Always review investments when they mature and choose your re-investments carefully so that you don’t invest in instruments that give low returns.
- You could create an income stream using instruments such as FDs. Use this to meet yearly or term expenses when your kid is in college.
- You can also look at tax-free bonds and PPF for tax benefits.
- In case you fall short of funds for your kid’s higher education, do not dip into your retirement savings. Instead, opt for an Education Loan. This way, the burden will fall on your children to repay the loan. It will also teach them financial discipline. Education Loans require you to start repaying the principal once your child gets a job. Since Education Loans provide tax benefits, your child can also enjoy those benefits when they are repaying the loan. You can also fund a part of the education expense and consider taking a loan for the rest. In case you do decide to take a loan, ask your children to repay the loan as quickly as they can. This will ensure that they are not burdened in their later working years and it will also free them up to take other loans such as a Car Loan.
When you are financially disciplined, your kids are bound to follow your footsteps.
Thinking about making a long-term investment for your child’s education? Mutual Funds might be just the thing.