As an Indian parent, you might appreciate the irony. We revel in dousing our kids with endless affection, and spurred by a consuming concern for their well-being, we span a lifetime securing their financial futures. En route, we are buffeted by an alarming array of financial choices and questions: Should I buy a child plan or is mutual fund the best way to assure funds for his later needs? Should I open a regular bank account or a child-special account? Should I take an education loan? Should I invest in the PPF or a fixed deposit?
As we stumble around, tarrying for the right financial answers, the irony manifests itself starkly. Blinded by traditional biases, friendly familial advice and an expansive ignorance about investment options, we invariably deploy a blinkered approach, leading to wrong choices for the beloved progeny.
We shall help delineate the options that will work for you and assure a better future for your child. More importantly, it will help enhance the decision-making ability of your kid and allow him to exercise his financial wit, which will serve him well in adulthood. And, of course, help reduce the irony for the next generation.
Should I buy child plans?
A combination of term insurance and mutual fund investment scores over child plans, unless you lack financial discipline.
Whichever way you look at it, a child plan evokes strong sentiment. Among parents, it’s an offer they just can’t seem to refuse. Among the marketeers of such policies, it stirs unmitigated joy at the response it evokes in parents. And among financial planners, it typically churns a feeling that approximates abhorrence. “Buying a child plan is possibly the worst thing that a parent can do,” says Mumbai-based financial planner Kartik Jhaveri.
Child plans are either traditional or unitlinked insurance policies, which also make investments on behalf of the policyholder. For the purpose of our argument, we shall only consider the market-linked version of child plans, or ulips. While these offer a lump-sum on the death of the policyholder like any other insurance plan, “one of the unique features of these is that they waive the premium in case of the parent’s death, ensuring that the planned investment remains uninterrupted and the child’s future is safe”, says Sanjay Tiwari, vicepresident, products, HDFC Life. This preplanned disbursal of tranches at specified intervals, along with the fact that it enforces investing discipline among people who want a dedicated instrument for their children, is what makes it a bit of a favourite among parents.
However, a big drawback with the child plans is that they are prohibitively expensive, with high mortality charges and a relatively small cover. The steeper charge is also because child plans are type II ulips, which give both the insured amount and the fund value to the nominee. Shuchi Sinha, a Delhi-based lawyer and mother of a five-year-old, agrees. “We (she and her husband) conducted our own research and found that not only is the inflow in case of child plans very high, but the cover is too small and so is the output, or the returns. So, instead, we decided to go in for a term cover-mutual fund combo. Now, both I and my husband have highcover term plans and we are investing in mutual funds via SIPs,” she says. This will ensure that their daughter, Anahita, gets a lump-sum amount in case of an eventuality as well as the high returns from the funds.
In fact, this combination of a term cover and mutual fund investment is the alternative that is readily advocated by most financial advisers. To ensure sufficient wealth creation, it makes sense to invest aggressively in equity mutual funds because of the spiralling cost of education and the high inflation. This will ensure that your child doesn’t fall short of funds when he needs them most.
Should I open a child-specific bank account? Should I get him a debit card? A kid-friendly account is advisable, as is a debit card, but while the latter makes for a good educational tool, consider other factors before taking it for the child.
How does a kid-specific account differ from a regular joint savings account? “A kid’s account is a customised offering for children below 18 years of age, which introduces them to the basics of banking, interest rate and goal-based saving,” says Puneet Kapoor, executive vice-president, Kotak Mahindra Bank.
While many banks offer ‘minor’ accounts as a default option for parents opening an account with kids, in others, you can also opt for a regular joint account. In both the cases, the parent or guardian operates the account, but the former offers various features and benefits that are not available in a regular account. For instance, the average quarterly balance (AQB) maintenance is much lower, or even waived, in child accounts Besides, parents can transfer a fixed amount from their own accounts to that of the child on a regular basis and invest in avenues like mutual funds. These accounts also contribute significantly to the financial education of your child. Not only is the child exposed to financial terminology and operations, but the option of making deposits in his account, writing cheques, getting personalised statements and making withdrawals from an ATM introduce him to bank functioning, giving him confidence and a sense of ownership. “It also inculcates the habit of saving and investing in children, which helps build a strong foundation for financial literacy,” says Kapoor.
Such accounts also typically offer a debit card to the child after a specified age, which varies among banks. While parents have the option of refusing it, and most invariably do, it may be more beneficial for the child than you think. Card transactions also enable the child to regulate the spending and saving from his bank account, and become responsible for his own money. Another advantage is that the usage of debit card acts as a kind of initiation for the child into the world of credit cards as later in life, and in building of good banking behaviour.
If, however, you feel that your child does not have the financial maturity to deal with the plastic, do not opt for it at an early stage. Wait till both you and the child can avail of this facility with more efficiency.
Should I invest in the PPF, FD or debt fund?
The PPF emerges as a winner if you are looking at an option dedicated to disciplined investment till maturity.
Which debt instrument should you invest in for your child, and why? The easiest options are bank fixed deposits and the PPF. If you are an evolved investor, you might even consider a debt fund. The simplest deciding factor would be the post-tax returns for each of these categories, but what lends to the complexity is the fact that this is not the only parameter to consider if you are investing for your child for the long term.
If one were to go only by the post-tax returns, the PPF and debt fund would score over the fixed deposit for people in the higher tax bracket (20-30%), but for those in the nil or lower (10%) bracket, the FD and debt fund would inch marginally higher than the PPF. Remember that the PPF offers the benefits of tax deduction under Section 80C at the time of investment, and exemption on interest and maturity amounts.
In the case of FDs, the interest and maturity amount are taxable, while the deduction under Section 80C is available only if you opt for the five-year tax-saving deposit. On this count, you could rule out a long-term FD since it will offer low post-tax returns .
As for the debt fund, the profit is taxed at 10% without indexation if you hold it for over one year (long-term capital gain), and there is no deduction available on investing.
However, if you are looking at these instruments as long-term investments dedicated solely for your child, then the attraction of high liquidity of a debt fund would work against it since you could be tempted to make a withdrawal. The tax-saving FD would score here because you can neither take a loan, nor make a withdrawal before maturity. In the case of the PPF, you can take loans after the third year and make partial withdrawals after the fifth.
Once you have considered these parameters as well as your priorities, you can pick the option you want, but we recommend the PPF for its clear advantages as a long-term investment tool.
Should I take an education loan?
Go for the loan even if you don’t need to, if only to instill responsible financial behaviour in your child at an early age.
If I have the funds, I will not take the additional liability of a loan, but if there is need, I shall avail of it,” says Malini Chawla, a Gurgaonbased homemaker from a business family, who has two daughters, aged 13 and 9.
This refrain is typical of Indian families. In fact, parents have been known to expend all their financial resources, even mortagaging their homes and risking their own retirement, in order to fund their children’s education. However, financial prudence calls for availing of this loan for several reasons. “It helps in ensuring that the parents’ retirement corpus is not eaten into, and could make the child more responsible in two ways,” says Jayant Pai, a Mumbai-based certified financial planner. A loan will also ensure that there is no pressure on the household cash flow while the child is studying. “In fact, you should take the loan even if you can afford it or there is no need simply to make the child financially responsible and wise,” says Jhaveri.
Another ancillary, though tempting, reason for parents to take the loan is the tax advantage. They are eligible for deduction under Section 80E of the Income Tax Act for the interest paid on this loan if they meet the specified criteria.
Besides, unlike earlier, now it is very easy to take an education loan since it is dispensed by almost all banks even though they do not advertise it overtly. Usually there is no collateral required for loans below 7.5 lakh and the rates are reduced for girls. Virtually every bank’s website lists out the eligibility criteria, documentation required, interest rates charged and the repayment terms.
Courtesy:
http://epaper.timesofindia.com/Default/Scripting/ArticleWin.asp?From=Archive&Source=Page&Skin=TOINEW&BaseHref=TOIM/2013/11/25&PageLabel=18&EntityId=Ar01800&ViewMode=HTML
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