friend of mine called the other day with an interesting request. She wanted to buy a gift for a five-year-old.

That's easy. I could immediately think of a dozen things a five-year-old would love to have. But the caller had something else in mind.

She wanted to gift an investment, more on the lines of an insurance policy. One that would mature when the child was around 18 years old; just in time to fund his or her educational needs. My friend was willing to part with Rs 25,000.

I thought it was an excellent idea (though the child would certainly not appreciate it right now!).

I suggested she gift the child a single premium policy.

What is that?

When you take a policy, you will have to pay the insurance company a fixed amount every year. This is known as the premium.

In some policies, this can be a one-time payment instead of an annual payment.

These are referred to as single premium policies. Pay the premium once and for all and the policy will stay in force till the end of the coverage period.

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Where they score

Single premium policies make for a convenient gift

You can make the payment and forget about it. The child gets the amount that is due on maturity.

You don't have to get bogged down with annual payments or concern yourself about what will happen if you lose touch with the child over time.

For instance, the Life Insurance Corporation of India has a money-back policy called Komal Jeevan. This is single-premium policy.

You pay the premium at one go and the child will get fixed amounts of money at various ages (18 years, 20 years, 22 years, 24 years, 26 years).

Where they fail

The premium for single premium policies is phenomenally high.

Taking the Komal Jeevan policy again, the premium would have to be approximately Rs 87,000 for a sum assured of Rs 1 lakh on maturity.

Sum assured is the amount for which the policy is taken. 

That is a very expensive gift to give someone (unless it is your own child).

Also, you may not have that much of money to spare.

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How much the child would get?

Let's say you buy the policy when the child is five years old and pay the premium of Rs 87,000.

This is what the child will get.

Totally, the child would get Rs 2,57,000. A tidy sum indeed!

Risk cover

This is known as the risk cover.

In the case of child policies, one must understand that the risk cover begins at the age of seven or two years after the commencement of the policy, whichever is later.

So, if the child is four years old (or younger), the cover will start only at the age of seven.

If the child is five years old, the cover will start at the age of seven.

If the child is six years (or older), the cover will not start when the child is seven years old; it will start two years after the commencement of the policy.

If the child dies before reaching the age where the risk cover begins, only the premium will be refunded. The nominee will not get any sum assured.

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I don't want to pay it at one go!

You also have the option of contributing annually towards this child policy.

You will have to do so till the child is 18 years old.

For the same policy of Rs 1,00,000 sum assured, the annual instalment would be approximately Rs 10,000.

If this is what you would like to do, then you have two choices.

i. Pay the instalments every year.
ii. Pay the first instalment and request the parents to do the rest (talk to them about it before you buy the policy).

What are the tax benefits?

If you still want to be generous and go ahead with such a lavish gift, then you might as well look at the tax options.

The author is chartered accountant and has been working in the banking and financial sector for the past 10 years.