PARK Financial Advisors

Akshata and Vidhan Kulkarni’s joy at getting their daughter admitted to kindergarten was tempered by a sudden realisation that they needed to start planning financially for her future.

In this article we evaluate the concepts around the child plans available in the market today. In summary, the child plans available today fare poorly on both the insurance and the investment parameters, as compared to alternatives available in the market.

Akshata and Vidhan Kulkarni’s joy at getting their daughter admitted to kindergarten was tempered by a sudden realisation that they needed to start planning financially for her future. Vidhan had heard from his colleagues about how expensive even primary school education was getting, and he could not imagine how much college education would cost by the time his daughter completed school. He now began to pay more attention to the innumerable Child Plan commercials by life insurance companies that were regularly aired between the cricket matches on TV; and wondered how to choose. With these thoughts, he approached me to guide him in planning the way forward.

What is a child plan?

I began by explaining the basic concept of a child plan, as is available in the market today. It has typically two components to it

• A life insurance on the parent
• An investment vehicle that accumulates your savings on a regular basis and pays it back around the time the child reaches college (typically when she turns 18-21)

These two components are thus very different in what they achieve to secure the child’s future, and any analysis must keep this distinction in mind at all times.

The Insurance component

Life insurance in the child plan ensures that the monies payable to the child for higher education are protected against untimely death of the earning parent. I cannot overplay the importance of this insurance – in fact, my observation has been that most people underinsure their life in these policies.

By mandate, the minimum life cover that you have to opt for in a child plan is

Sum Assured = Term * Annual premium / 2

Thus, if you take an 18 year plan, paying Rs. 50,000 every year, the minimum life cover is Rs. 4.5 lakh. Now, if you have no other life insurance, a little bit of thinking would reveal to you that this life cover is woefully inadequate. After all, if you can afford to save Rs. 50,000 a year towards a single plan, it is likely that your annual income is atleast Rs. 5 lakh. Thus, the insurance for the child does not even cover one year of income!

Instead, one would recommend a life cover of atleast 7-10 times your annual take home pay, if not more. This provides adequate security and cover for your spouse and child to financially sustain in the event of your untimely demise.

Of course, you need not rely on a child plan to provide you this insurance. A term insurance plan of the required amount can be bought from any of the major life insurance players. Analysis reveals that the rates are much more competitive and customer friendly if done this way, rather than through a child plan.

The Investment component

As mentioned earlier, the other function of a child plan is to enable you to save regularly and pay back the money (with returns) when the child is entering college. Here, it is important to note that the plan is simply a pass-through – it invests the money in a set of securities on your behalf, for a fee. The plan in itself does not have a mechanism to generate returns, let alone freebies. Depending on how the securities perform, the amount available to the child gets decided.

Thus, there is no such concept as a freebie here – any benefit that the plan offers you (flexibility to switch, loan facility, premature withdrawal, waiver of premium, etc) is paid for by you in full as part of the premium. For instance, if a college promises your child ‘free laptops’ after charging a fee of Rs. 10 lakh, you would recognise that the laptop is not really ‘free’. All that the college is doing is allocating a portion of the fee to purchase laptops and distribute them. Similar is the case with additional features thrown in by insurance companies. Each feature has a cost that gets cut from your premium payment.

The investment can be either in debt securities (in the traditional plans) or in equity instruments (the unit linked plans). Given the strength of equities in the long term, any plan that is greater than 5-7 years in duration should be invested predominantly in equities. Else, it is likely that you will end up earning very low returns and not covering the inflation in education costs.

Of course, as in case of insurance, the alternative here is to invest in equity mutual funds instead of child plans. Analysis reveals that this (equity mutual fund) may actually be a much better option, since it has much lower transaction costs and is more flexible and liquid. Most child plans have upfront allocation charges in excess of 15%, as against only ~2% for mutual funds!

Putting it together

In summary, the child plans available today fare poorly on both the insurance and the investment parameters, as compared to alternatives available in the market. The term insurance beats the child plan hands down, while the mutual funds provide a lower cost way of investing the corpus.

Yes, these alternatives require somewhat of a more hands-on approach to financial planning. But given that it’s your child’s future that we are talking about, it is probably well worth it!

PARK Financial Advisors
www.parkfinadvisors.com
info@parkfa.com