Think of your kids' future... and get your investment mix right

Everyone wants the best for their children. Whether it's health, education or career, parents just don't compromise on quality. But this calls for intelligent planning and investment, so that they would have funds at their disposal at the right time and place. It would be prudent to start investing early so that the capital builds up to a substantial amount to fund the child's needs.

This calls for safety and liquidity in your investments and of course, returns. One must balance these features to arrive at a proper investment mix.

How does one go about the process? Here are a few methods. The most traditional form of investment has been bank fixed deposits. These are safe instruments and can be taken for specific period of time from a minimum of 15 days to a maximum of about 10 years. You can open these accounts in the name of your child and appoint yourself as guardian.

When the child becomes a major, he will be able to use the funds. The interest rates, although not very high, are fairly safe. They vary from three per cent up to a maximum of about 5.5 per cent depending on the term selected.

Once you lock into a fixed deposit for a specific term, your deposit will continue to earn the same rate of interest till maturity, irrespective of any changes in interest rates. Interest is usually compounded quarterly and paid along with the principal although you will also have an option of receiving your interest at regular intervals.

An important aspect here is the taxability of interest income. The interest will accrue in the name of your child, but if he is a minor, the income will be clubbed in the hands of the parent with higher income.

There is, however, a deduction upto Rs 1,500 per year for such income clubbed in the hands of any parent. Once the child becomes a major, he/she will be taxed.

As far as liquidity is concerned, these instruments are not considered very liquid as they attract early withdrawal penalties. However, that would not matter, as the intention in any case, is to save for the long term.

Fund options
Several mutual funds have children specific open-ended schemes that are meant for long-term growth by capital appreciation. The units of the scheme can be purchased when your child is about six or seven years old so that when he reaches the age of 18, the capital would have built up to provide him with a lump sum.

You can purchase the units from the fund or the market at the Net Asset Value (NAV) as on the date of purchase. As the schemes are aimed at long-term capital appreciation, the portfolio mix mainly comprises of debt funds. This ensures maintenance of capital and fixed returns. A small portion of the portfolio is invested in equity so as to enhance capital value.

As the aim is to provide lump sum funds after a specific period, there is a minimum lock-in-period. This means, once the units are purchased, you cannot sell them for a specified period. If funds are prematurely withdrawn, an exit load will be levied. An exit load is like a charge for premature withdrawal. Some companies also levy an entry load, that is, you will have to pay a charge at the time of purchasing these units. So all these entry and exit loads can make investments in mutual funds quite an expensive affair.

There is no guarantee of any assured return as dividends and NAV are susceptible to market risks. On the taxability front, on redemption, the capital gain will be taxable in the hands of your child (if over 18 years of age) and it will not be clubbed in your hands.

There is also a money-back policy offered by insurance companies, which is suitable if you are looking at investing for your child's future. You will have to pay premiums yearly, half-yearly or quarterly for a specific period of time, usually till the child completes 18 or 21 years. The benefits of the policy will be paid out to the child in specific instalments, either during the premium paying term or on completion of the premium paying term.

So in a sense, your premiums remain locked up in this case too. Along with the payouts, the child will also receive bonuses that the company may declare from time to time. These bonuses would depend upon the growth and performance of the company and may vary periodically.

Additionally, there will be a risk cover on the life of the parent so in case of the unfortunate death of the parent during the policy period, the child will receive the sum assured and will also continue to get the periodic benefits. So there is a guaranteed return in the form of periodic instalments. Also, there are tax benefits under Section 88 and Section 10(10D) of the Income Tax Act. That means you will get a rebate and the receipts from the policy will be tax-free in the hands of your child.

One has to remember that these options are not mutually exclusive and one can have a good mix of all of them depending upon the needs and requirements of each individual case.