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Thanks to India's burgeoning population, it has become necessary to plan for the admission of a child to a good school, as soon as the mother's pregnancy is confirmed. Similarly, thanks to the ever-rising cost of living, the same dictum is applicable to investment planning for your children. The responsibility of looking after the welfare of their children, both in the present as well as the future dimension, cannot be shouldered by anyone else but the parents.
There was a time when an individual could build up an estate in the names of his minor children, slowly and steadily. This benefited the parents immensely. Some income, which otherwise would have been taxed in their hands got diverted to children and taxed in their hands. A separate income tax file in the name of the child was certainly useful in diverting income.
Not by Gifts
Now that the gift tax has become history, many people have started giving gifts to their close family members, left right and centre.
We were very much surprised to find a grandfather approaching us to ask whether he should choose CGGF of UTI or PPF for his three minor grandsons because gifts are now free from tax. He has five granddaughters, but he wasn't interested in them. Strange!
Finance Act 1992 inserted Section 64(1A) of Income Tax Act, and corresponding provisions in Wealth Tax Act, negating tax-beneficial options of saving for your children through gifts. Accordingly, the entire income and wealth of a minor child, irrespective of who the donor is, will be clubbed in the hands of that parent whose income and wealth (before clubbing) is higher among the two. The clubbing provision is not applicable only in the case of mentally or physically handicapped children.
It is also not applicable if the income is earned by the child himself or herself through his manual work or specialised knowledge. Such children can file tax returns in their own names and claim the various concessions. However, and this is important, when savings from such incomes earn interest, that interest will be clubbed in the hands of the parent. This is so, since such interest income does not flow from manual work or specialised knowledge of the child.
This clubbing is much harsher in the case of children. In the case of gifts to spouse or daughters-in-law, the income arising out of gifts is clubbed. The income on income escapes the clubbing. In other words, if you make a gift of Rs. 1 lakh to your wife and she invests it say, @10 per cent p.a., she will receive Rs. 10,000 by way of interest after one year and this amount will get clubbed in the hands of the husband. Say she invests this Rs. 10,000 in the same avenue and receives Rs. 10,000 as interest against the original gift and Rs. 1,000 extra against the new deposit. This extra amount is taxed directly in the hands of the wife or daughter-in-law.
In the case of gifts to minor, the entire income is clubbed in the hands of the parent, irrespective of who the donor is. By way of a small mercy, an exemption up to Rs. 1,500 per child is granted from the clubbed income of the child. So, giving gifts is not a very sensible way of financial planning of your children.
Not through 'Specialised' Investment Products for Children
It is unfortunate but true that various agents, brokers, consultants, portfolio managers and other specialists in the field, more often than not, touch a sensitive chord in your bosom for your child only to sell a product that may be good for you but not your child. Unfortunately, when it comes to investing, most parents look for investment products that are actually termed as 'Children's Plans.' This in itself is fraudulent in nature. Investment products do not come with an 'Adults Only' certificate. You can use precisely the same investments for your child that you use for yourself.
The following are three glaring instances and you should avoid using their schemes designed for children.
1. Life Insurance
It is possible to take a policy in the name of children, major or minor, and avail of some tax deduction. Such life insurance plans are nothing but modified endowment or money back policies. The label is changed, the product is more or less the same. Putting it differently, Naam Badalne Se Kaam Nahi Badalta. There are a plethora of policies "designed" for the children. We do not understand the purpose of this. In most cases, a child is not a breadwinner for the family and his/her demise though devastating emotionally would make no difference to the actual subsistence of the family.
If you need insurance for yourself, buy term insurance. All the money that you would save on account of the low premium can be invested for the long-term for your child.
2. UTI/MF Schemes
All mutual funds have devised some special schemes for children taking advantage of various exemptions under the Income Tax Act.
Most of them are designed to circumvent even the clubbing provisions by linking the maturity to when the child becomes major. Some others like LIC Mutual Fund's Dhanvidya take the shelter of Section 10(26) granting exemption on any scholarship to meet the cost of education. The applicant continues to be the owner of the units but the income is diverted at source and is payable as scholarship to the child. Moreover, the holder is also entitled to the benefit of long-term capital gains.
3. ULIP
ULIPs have also started being marketed as Children's Plans. Again, if it is a traditional ULIP or a Child Plan, it still remains an ULIP -- Understand the expense structure, especially during its first year, well before committing your funds.
Why we do not approve of gifts
We appreciate the sentiments in giving gifts to your minor children or grandchildren but do not approve of it.
Since gift tax has been abolished, many individuals have gone on a spree of giving donations to their close relatives. It is important to understand that gifts need not be given if the donee has no use for it in the present dimension.
Prior to the abolition of Gift Tax Act, a paltry amount of Rs. 30,000 was exempt from tax. Therefore, it was prudent to give a gift up to Rs. 30,000 regularly every year. This catered not only for emergency situations but also received a large capital the income from which was no more clubbable.
Risk of Giving Gifts
Gifts, once given, are irrevocable. So are the clubbing provisions. There are numerous instances where the donor has suffered no end for having given a gift.
Invest for Your Children in Your Own Name Instead
Under the present scenario, it is a prudent to invest the funds in your own name, earmarking the capital for the child, as and when he or she may need it in future and still save the same amount of tax. You will command respect from all your family members, including your daughters-in-law because you, and not she have the title. Give a gift only when you are convinced that it is necessary to do so.
The only thing you need is discipline in keeping the earmarked funds invested over the time that your child attains majority, so that the power of compounding makes the money grow healthily.
The best gift you can give to your child is -- No Gift.
The best plan you can have for the child is -- Write a Will.
The bottom line: Investing for a child is no different than investing for yourself. The principles remain the same. Remember, investments do not carry an 'Adults Only' certificate, just an 'Under Parental Guidance' one.
Excerpt from Taxpayer to Taxsaver (FY 2007-08) by A N Shanbhag. Price Rs 235.
Shanbhag is a best-selling author and a very widely syndicated columnist on personal finance and taxation.
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