Say NO to Children Policies

Nikhil and Rekha are expecting their second child next month.  Their first daughter is now 3 year old and is thrilled to see the new born.  Parents want to start planning for the child’s future education. They want to give the best possible education to their kids and want to plan for it.

Rekha’s uncle is an insurance agent and he had already suggested 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 to be used for the graduation expenses.

The details of the policy are given below:

1. Yearly premium to be paid – 57,000
2. Number of years to pay – 18 years
3. Total premium payable in 18 years – 10.26 Lakhs
4. Approximate maturity amount after 18 years – 18 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. If you want to reduce / increase the investment, it is not possible. Once you join the scheme, there is no escape route. If you stop paying premium, then the returns can be pathetic. If you surrender the policy after paying for few years, you may not get what you have already paid! It s a trap.

Also Check: How much amount do you need for your retirement?

Child Insurance Plans – Is it better than the normal insurance plans?

In children policies, the insurance company will waive the future 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 57,000 as the premium, the company will charge around 60,000 for a child policy of 10 lakhs and the benefits will be like under.

1. The maturity amount of 18 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 waive future 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 a 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 18 Lakhs will be around 4.5 lakhs. Can you afford a decent education (graduation) for your child with 4.5 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 14.7 lakhs assuming the current rate of interest of 8%. You can reinvest this amount in debt funds for the next 3 years (6% returns) which will create around 17.5 lakhs when your child is 18. The amount of 54,000 in the last 3 years can be invested in a bank account. This way, you can create around 19 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. Moreover, you have the flexibility to increase or decrease your investments in PPF every year.

Sukanya Samriddhi Account

This is another good option for the girl child. You can invest in the scheme for 14 years. Assuming yearly investment of 54,000 per annum with the current interest rate of 8.5% will create around 13 Lakhs in 14  Years. Assuming an interest rate of 7% in the last 3 years, it will grow to around 17.8 Lakhs in next 4 years.  50% of this can be withdrawn for the higher education of girl child and remaining amount can be used for the marriage.

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 10% return, you can expect around 27 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. Here also, you can increase or decrease your investment as you like it.

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: Flexibility

You are not sure, when you require the amount for the child higher education. It can start from 17^th or 18^th 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.

Nikhil is busy now in registering a new SIP online for this after understanding the problems attached with the insurance policy. Rekha can somehow manage her uncle.