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

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

Insurance agents are prone to pitch children's plan to those who have kids. However, they do so to grandparents also. The sales pitch: You should gift something to your grandchildren also. In many cases, grandparents fall for it.

Just last week, 67-year old Pune-resident RP Sinha was pitched a children's plan for his 7-year old grandson. The insurance salesperson of a repuated private sector bank was pushing a unit-linked child plan (ULIP) to Sinha. Sinha thought it was good idea to save for his grandson as he also had his responsibilities towards him.

Sinha planned to save Rs 500,000 for his grandson. But given his age he was advised a 5-year policy term. The premium ran into over Rs 100,000, which was very expensive for Sinha. According to insurance comparison website MyInsuranceClub.com, there are no children's plans available for a 67-year old.

But a for a 60-year old, the premium for a Rs 500,000 policy with a term of five years (child age = 7 years), there are two traditional plans available --- LIC's Marriage Endowment or Educational Annuity Plan, Reliance Life Insurance's Child Plan. Annual premium = Rs 100,000 – Rs 150,000.

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Says certified financial planner Anil Rego, “Investment for any kind of goals should happen through a combination of products than just one avenue. If the investment term is long, say ten years or more, one could opt for a couple of risky products among a basket of 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 available both on traditional and unit-linked platforms. Traditional plans offer fixed returns, either at maturity or at fixed intervals. Their investment strategy may be conservative or aggressive.

Unit-linked plans have a higher exposure to equities. These work in two ways. A plan can cover either a parent or a child. In the later case, a child’s life is covered only after he / she 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 aged 7 to 14 and so premiums for children covered can be very high. The mortality rate dip after that till age 20. Also it doesn't make sense to insure a child for it doesn’t have any dependants.

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If a parent is covered or made the policy proposer and he/she passes away, the insurer pays the premium so that the child receives the targeted corpus on maturity. But the premiums are no less for policy proposer in lower age brackets than Sinha.

Sample this: For a Rs 10 lakh (Rs 1 million) child plan with a 35-year old proposer (child age = 5 years) and 13 year term, the premium can be anywhere between Rs 75,000 and Rs 100,000, across insurers. For a Rs 50 lakh (Rs 5 million) policy, the premium can be anywhere between Rs 350,000 and Rs 650,000, across insurers.

Despite strict pricing norms by the insurance regulator, “unit-linked plans continue to be expensive compared to other instruments,” says certified financial planner Suresh Sadagopan.

The policy allocation charge eats into your premium before it is invested and is applicable for most part of the policy term.

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This ranges between 5-7 per cent in the first year and is lowered to 2-3 per cent for the subsequent years. Then comes the policy administration charge, a fixed (typically, Rs 40-50) or variable (as a percentage of the premium) monthly cost, varying with insurers.

And lastly, the fund management cost of 1.25-1.35 per cent, annually. In fact, the cost of any feature given by these plans is built in the premium. For instance, the cost of premium waiver benefit is built into the mortality rate mostly.

A better, low-cost option is mutual funds. These charge a fixed expense ratio annually of 2.25 per cent (equity diversified funds). On average, equity funds return 12-15 per cent annually, which could help create a significant corpus over a long term or 10-15 years.

“Many ULIPS are not doing well and may give lower maturity proceeds compared to ulips. Plus, if a mutual fund scheme underperforms you have many options to switch between, which may not be the case in ULIPS,” adds Sadagopan.

Investment through fixed deposits is also a good option, in case you are risk averse. At present, banks are offering 8.50-9 per cent interest on a one-year term deposit. You should have a low-cost term plan for yourself.