Can Child Insurance Plans Help You Plan Your Child’s Future Needs?

November 27, 2021 Mutual Fund

Right from the birth of their baby, parents do everything in their power for the child to have a brighter future and they recognise that education is an investment towards one’s development and a necessity to lead a successful life. Quality education in India can cost anywhere from Rs 5 lakhs to 30 lakhs, whereas studying abroad can cost a minimum of Rs 25 Lakhs. And, the rate of education inflation in India is 11%-12%. Even if we consider the lower end of that scale and assume the rate of education inflation as 10%, in the next 15-20 years you can expect the cost of education to increase by four to six times of what it is today, when your child will be old enough to opt for professional education. This means that education in India will cost a minimum of Rs 25 Lakhs, whereas studying abroad could cost a minimum of Rs 1.25 Cr in 15-20 years. Thus, the constantly rising inflation is the primary reason why traditional financial instruments, like fixed deposits, will possibly not create an adequate corpus for their education.

Raising such a high amount overnight is not possible for the common man. That’s why many banks and other financial institutions have launched several long-term investment plans that focus mainly on building the child’s education corpus. However, most of these plans are insurance-based, that apart from providing insurance coverage, it will also generate returns on the investments. Such insurance plans are called Unit-Linked Insurance Plans (ULIPs), similar to mutual funds, which further invest the investments collected from policyholders in equity shares, debt instruments, bonds, etc.

According to the Future Fearless Survey conducted by Ageas Federal Life Insurance and YouGov India, most parents prefer investing in such ULIP products for their children as they are investment-cum-insurance plans that will provide financial assistance even in the absence of parents. However, most financial experts advise investing in equity mutual funds that are relatively risky but generate higher returns than child insurance plans. To make the right choice, it is crucial to know the difference between them.

1. Nature of Investment:

Child insurance plans are long-term investment-cum-insurance plans that generate returns on investment as well as provide a life insurance cover. Generally, the insurers offer these two options of child insurance plans — ULIPs and traditional plans. As ULIPs are unit-linked plans, they invest in equity shares, debt instruments, and bonds, etc. and offer a small portion as fixed returns. Whereas, traditional insurance plans invest in bonds and other low-risk financial instruments and offer guaranteed maturity returns to the policyholders.

Unlike insurance plans, you can invest in mutual funds for the short-term, medium-term, or long-term, depending on your financial goal/s. The fund house/Asset Management Company (AMC) pools money from many investors, like you, with similar financial goals and your money is professionally managed by the fund manager. Investors are allotted with the fund units based on the amount they invest. Hence, each investor generates returns directly proportional to the amount they have invested.

2. Returns:

Though traditional child insurance plans do not generate decent returns because they invest in low-risk financial instruments, they offer guaranteed returns on maturity. The ULIPs are considered riskier and can generate higher returns than traditional plans as they invest a considerable portion in equity. However, many ULIPs offer a small fixed sum as some portion is still invested in the low-risk financial instruments.

Equity mutual funds generate high returns because a major portion is invested in high-risk financial instruments. You can seek professional advice from financial guardians, experts, or councillors on risk mitigation by diversifying the portfolio across several sectors and stocks.

3. Expense ratio and Charges:

Child insurance plans usually have higher asset allocation charges and underlying expenses, which the insurance agent might not inform you about at the time of buying the plan. With no cap on the expense ratio of insurance plans, the insurance company can charge you higher fees compared to mutual funds. Mutual funds charge considerably lower fees as the Securities and Exchange Board of India (SEBI) has capped the expense ratio on mutual funds to 1.05%. Moreover, unlike insurance plans, mutual funds stay transparent about all fees and charges.

4. Life Cover:

Since a child insurance plan is an insurance policy, it typically offers life insurance cover at 10 times of your annual premium. So, if your annual premium is, say, Rs 1 Lakh, it will provide you with a life cover of Rs 10 Lakhs till the end of the policy. Whereas, there is no such life cover offered on mutual funds as it is a pure return-generating financial instrument.

5. Tax Benefits:

Premiums that you pay towards a life insurance policy qualify for a tax deduction of up to Rs 1.5 lakhs, under Section 80C of the Income Tax Act, 1961. Moreover, if the premium is not more than the 10% of the sum assured, then you can avail tax exemption on the maturity benefit or death benefit (sum assured and accrued bonus), under Section 10(10D) of the Income Tax Act, 1961.

Whereas, mutual funds offer a tax deduction only for investments made in Equity Linked Saving Schemes (ELSS), and there are no tax benefits on any other types of mutual fund schemes. Furthermore, mutual fund redemptions are taxable as per the tax bracket applicable to the investor.

6. Convenience:

The Child Insurance Plans typically start with a ticket size of Rs 25,000 and have a lock-in period of a minimum of 5 years to until the maturity of the policy, depending upon the type of plan you have chosen. But, in the case of mutual funds, there are no such restrictions. Most mutual funds let you start investing with a minimum of Rs 500 (for SIPs – Systematic Investment Plan) and Rs 1000 (for lump sum investments). Besides, mutual fund schemes do not have a lock-in period, unless you have invested in close-ended mutual fund schemes that work as tax savers.

Should you prefer a Child Insurance Plan or Equity Mutual Funds for your child’s future needs?

Certain ULIPs might be worthwhile if they have been chosen after thorough research and assessing your requirements. However, if we compare such investment-cum-insurance plans to carefully selected equity mutual funds, the ULIPs might not prove to be the right investment option for any long-term goal, such as child’s education, child’s wedding, or your retirement.

Therefore, it is advisable to invest your money into carefully selected equity mutual funds for your child’s future needs, instead of investing in Child Insurance Plans that neither generate decent profits nor provide adequate insurance coverage. Besides investing in equity mutual funds for your child, you should also buy a term plan to financially secure their future in your absence. A term plan offers maximum coverage at an affordable premium, unlike investment-cum-insurance plans that offer life insurance coverage of only up to 10 times of the annual premium. You can read more about the best term life insurance plans along with the comparison of their premiums here.

This article first appeared on PersonalFN here