Child plans: Costly way to save for children's future

Parents should opt for a combination of mutual funds and fixed deposits

Grandparents might find it difficult to get insurance cover for themselves but insurers are willing to woo them to buy children’s plans for their grandchildren. Many fall for the sales pitch. After all, their emotional buttons are being pressed with slogans like ‘insure your grandchild’s future’.

R P Sinha, 67, wanted to save Rs 5 lakh for his seven-year-old grandson. But when he was quoted a premium of Rs 1 lakh for a five-year policy, he refrained. He has chosen to make a fixed deposit instead, a move is supported by financial planner Anil Rego. But Rego also says saving in a combination of products would be more fruitful. “If the investment term is long – 10 years or more – one could also opt for a couple of risky products. However, if the horizon is less than five years, it is better to play safe and insurance is ruled out completely.”

Children’s plans are offered both as traditional and unit-linked. Traditional plans offer fixed returns, at maturity or at fixed intervals. Unit-linked plans can either cover the parent or the child. A child is covered only after s/he is seven. Experts feel this is a better option than covering a parent. Reason: the earlier you start, the lower the risk and the higher the investment tenure. At the same time, mortality rates are higher for children in the 7-14 years age group and so premiums for a child can be high. Mortality rates dip after that till the age of 20. If a parent is covered and he passes away, the insurer pays the premiums and the child receives the targeted corpus on maturity. But the premiums aren’t always less in lower age brackets from what Sinha experienced. For a Rs 10-lakh child plan with a 35-year-old parent (child age = 5 years) and 13-year term, the premium can be anywhere between Rs 75,000 and Rs 1 lakh, across insurers. For a Rs 50-lakh policy, the premium can be between Rs 3.50 lakh and Rs 6.50 lakh.

Unit-linked plans continue to be expensive compared to other instruments, say certified financial planners. From the premium you invest, a policy allocation charge (PAC), ranging between five and seven per cent (first-year) is deducted. In subsequent years, it lowers to two-to-three per cent. Next, policy administration charge, typically a fixed monthly cost (of Rs 40-50) is deducted. Finally, the fund management cost of 1.25-1.35 per cent is levied yearly.

A better, low-cost option is mutual funds. These charge a fixed expense ratio annually of 2.25 per cent (equity diversified funds). On an average, equity funds return 12-15 per cent annually, which could help create a decent corpus over 10-15 years. “Many Ulips (unit-linked insurance plans) are not doing well and may give lower maturity proceeds compared to mutual funds. Plus, if a fund scheme underperforms, you have many options to switch between, which may not be the case in Ulips,” points out a financial planner.  Investment through fixed deposits is also a good option, in case you are risk-averse. At present, banks are offering 8.5 to nine per cent interest on a one-year term deposit. You should have a low-cost term plan for yourself.