Why you should avoid children policies?
Nikhil and Rekha are expecting their first child next month. Both are busy in making all arrangements to welcome the baby. They want to start planning for the child’s future education. They want to give the best possible education to their kid and want to plan for it.
Rekha’s uncle is an insurance agent and he had already recommended a long term savings plan for the child’s future. He suggested them to go for a 10 lakhs policy with 18 year duration so that the maturity amount will be payable when the child is aged 18.
The details are given below:
1. Yearly premium to be paid – 54000.
2. Number of years to pay – 18 years
3. Total premium payable in 18 years – 9.72 Lakhs
4. Approximate maturity amount after 18 years – 17.56 lakhs (assuming the current bonus rate)
What are the drawbacks of this scheme?
The return from this scheme is around 6% with a life insurance cover of 10 lakhs. Some banks are offering this rate of interest for their savings bank account. Such schemes are not flexible. Once you join the scheme, there is no escape route.
Child plans – Is it better than the normal insurance plans?
In children policies, the insurance company will pay the premium in case of death of the proposer. The child will get all the benefits as planned! This is the sales pitch by insurance companies. Is it a better way to plan for children’s future? No.
All insurance schemes are designed with certain basic assumptions regarding mortality, interest rate, bonus etc. Any extra feature is coming at an extra cost.
Let us take the above example. Instead of charging 54,000 as the premium, the company will charge around 57000 for a child policy of 10 lakhs and the benefits will be like under.
1. The maturity amount of 17. 56 lakhs will be payable in 4 instalments starting from age 18.
2. In case of death of the proposer 10 lakhs will be paid immediately. The company will pay the premium for the child. All the maturity pay outs will continue.
Let us see the maths behind this.
By paying the maturity benefits in 4 instalments, the company is gaining some amount. Now let us see the death benefits. In case of death of the proposer, the company is paying 10 lakhs immediately and it pays the future premium on behalf of the policy holder. This means around 20 lakhs additional liability for the insurance company. The additional premium of 3000 per year is more than enough to offer this provision. The company is collecting premium for this 20 lakhs term policy along with 10 lakhs endowment policy!
Is this sufficient for your child?
Assuming an inflation rate of 8%, the present value of this 17.56 will be around 4.4 lakhs. Can you afford a decent education for your child with 4.4 lakhs now? This shows you have to go for higher value policy, if you want to go through this route.
Alternate route for children goals
For conservative investors:
You can buy a term policy of 20 lakhs with an annual premium of 3000 and the balance 54,000 can be invested in PPF. Let us see the benefits under this scheme.
After 15 years, the PPF account will have 15.4 lakhs assuming the current rate of interest of 8.7%. You can reinvest this amount for the next 3 years. The amount of 54,000 in the last 3 years can be invested in a bank account. This way, you can create around 21 lakhs at the end of 18 years. In case of death of the proposer, the nominee will get 20 lakhs immediately, which can be invested for child’s future needs. In both the cases, the benefits are more than the insurance policy.
For other investors:
After buying a term policy of 20 lakhs with annual premium of 3000, you can invest the 54000 by monthly SIP of 4500 in a diversified large cap mutual fund. Assuming a 12% return, you can expect around 32 lakhs from this when your child is aged 18. In case of death of the proposer anytime, the nominee will get 20 lakhs from the term policy. This option is much attractive compared to the earlier options.
Still better option
You can go for a combination of SIP and PPF. This can help you in going for higher SIP in the first 10 years and then reduce the SIP as you are nearing the goal. The PPF can be kept in force by paying the minimum amount of 500 in the initial years. You can gradually increase the contribution to PPF. In the last 3-4 years, the entire contribution can be in PPF. The accumulation in equity fund has to be shifted systematically to debt funds in the last 3-4 years to protect your savings from any last minute volatility in the market.
Advantages of mutual fund option:
You are not sure, when you require the amount for the child higher education. It can start from 17th or 18th year and can go up to age 25. In the case of children policies, the pay outs are pre fixed and it may not match your requirements. You must go for a flexible investment scheme, where you have full control while paying and while withdrawing. Mutual fund offers this flexibility with maximum tax efficiency.
You have more flexibility in mutual fund option. You can either increase or decrease your SIP amount as per your convenience. You can change the funds, if the selected fund is not performing well. But in the case of insurance scheme, once you join, there is no flexibility. You have to pay the same premium for the full term. If you stop premium in between, you will get only the surrender value which is very less in most cases.
Melvin Joseph
SEBI registered Investment Adviser
SEBI registraton number -INA 000000342
Finvin Financial Planners
10. Ground Floor, Olive Excel CHS Ltd
Plot No- 16, Sector 42, Nerul, Navi Mumbai – 400 706
Mobile: 91 9820843739
Website : http://www.finvin.in
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