Financial planning: No childs play

Written by Saikat Neogi | Updated: Sep 9 2014, 17:54pm hrs
CorpusAn individual must identify the goal, corpus required and the time-frame of investment. (PTI)
For every parent, securing the finances for their childrens education is one of the top priorities. Given the ever-increasing education expenses, it is essential to plan for it early with proper asset allocation and rebalance the portfolio as and when required.

To begin with, an individual must identify the goal, corpus required and the time-frame of investment. Besides these, one must understand the risk profile of the investments, especially if they are market-linked. Typically, for higher education education expenses, if the present value is Rs 10 lakh, after 18 years, the required corpus would be close to Rs 29 lakh or three times the present value, assuming an annual inflation of 6%

Brijesh Damodaran, managing partner of BellWether Advisors LLP, says investment for childrens need must comprise a combination of a child plan policy from an insurance company, mutual funds through systematic investment plan with equity and debt exposure, direct equity investment for the more enterprising lot and even real estate. There is no right way to invest, but you should invest only after understanding the various investment avenues and frame a proper asset allocation strategy, he says.

As per Income Tax Act, 1961, if an individual invests in the name of the child, the income generated from such investments is clubbed with the individual's income and taxed accordingly. But if you transfer the money through a deed to a child who is over 18 years of age and invest in his name, the income generated will not be clubbed with your income.

Public Provident Fund (PPF) is an ideal avenue for risk-averse investors to provide for childrens future needs, as it guarantees the principal invested and returns. One can invest up to Rs 1.5 lakh in PPF in a financial year, which gives annual compounded return of 8.7% at present. When an individual opens a PPF account for his minor child, the childs account is maintained under the guardianship of the parent and both accounts are seen as one and the overall limit cannot exceed Rs 1.5 lakh. Either of the parents can open a PPF account on behalf of the minor. The documents required are a passport-size photograph, proof of age of the child and PAN of the guardian.

Investment can be made only in multiples of Rs 500 with 12 maximum transactions a year. PPF investments enjoy a tax deduction benefit under Section 80C of the Income Tax Act and the interest earned is completely tax-free. The duration of a PPF account is 15 years and can be extended for blocks of five years. The account can be opened at a bank or a post office.

So, if you invest Rs 1.5 lakh each year and the interest rate remains at the current rate of 8.7%, at the end of 15 years, the total value will be around R46.76 lakh. This can be a good corpus for your child's education or marriage. Though the PPF tenure is for 15 years, partial withdrawal is permissible every year after the completion of seven years.

Insurance is another way to save for your childs kitty. One can choose between endowment and unit-linked insurance plans, which give tax benefit under Section 80C, where premiums up to Rs 1.5 lakh are allowed as a deduction from your taxable income every year.

Under Section 10 (10D), the benefits from the plan are exempt from tax. Insurers also offer single-premium child plans and even customise the policy according to the requirement of the child. Under child insurance plans, one can invest a fixed amount as a premium for a specific period and get the fund value at the end of the period.

The risk cover in child insurance plans is for the earning parents and not the child and all maturity benefits continue irrespective of the death of the life insured.

However, like all insurance products, there are costs involved like mortality charge, premium allocation charge, policy administration charge, fund management charge and surrender and fund switch charges.

Analysts say if one needs a lump sum for the child's higher education, one should go for child traditional endowment policies. If the child is completely dependent on the parent's money, it makes sense to go for a term policy. This will take care of the financial need in case of untimely demise of a parent.

Moreover, one must read the fine print carefully before investing in any child insurance plan as some insurers specify that the risk cover becomes effective after two years of the commencement of the policy.

One should also look at the option of investing in mutual funds. They generate more returns as, traditionally, equity linked-investments generate more returns in the long run.

A regular systematic investment plan of a mutual fund is an ideal way to accumulate funds for children's education or marriage needs as they deliver double-digit returns. However, unlike insurance, mutual funds do not have protection,which is an important component in a child plan, says Damodaran.

Baby steps to success

Plan early with proper asset allocation and rebalance the portfolio as and when required

To begin with, identify the goal, corpus required and the time-frame of investment

Understand the risk profile of the investments, especially if they are market-linked

Experts say investment for childrens need must comprise a combination of a child plan policy from an insurance company, mutual funds through systematic investment plan with equity and debt exposure, direct equity investment for the more enterprising lot and even real estate