Every parent wants the best for his/her child. It is every
parent’s wish that financial constraints do not come in way of his/her child’s
education or career. Hence, when you are approached with a specific investment
plan to provide for your child’s future education or wedding expenses, the
product becomes too irresistible to ignore.
The sales pitch is so strong that you start to feel guilty if
you choose not to invest in such a product. After all, the product has
everything. It has an element of insurance, offers attractive returns and if
the most unfortunate were to happen, the insurance company pays all the future
premiums on your behalf.
There are many child plans offered by various life insurance
companies. All such products have a similar structure although specifics might
vary a bit. Child plans come in two variants: Unit linked insurance plans
(ULIP) and Traditional (guaranteed payout) plans. Unit linked child plans
provide market linked returns.
Should every parent buy a child plans
for his/her child? Or are there better products available? Is a simple
combination of term insurance plan and mutual funds better than a child plan?
We have always maintained that you must buy those financial products that you
need to buy, not what the intermediary (agent/broker) wants you to buy.
Therefore, before you purchase any financial product, you must
understand all its costs and benefits and compare its performance against the
competing products. In this post, we shall focus on unit linked child plans and
do an objective assessment of the product features and performance and assess
whether such plans should be part of your portfolio. We shall discuss about
traditional child plans in a subsequent post.
Similarities between unit
linked child plans and regular ULIPs
Like regular ULIPs, unit linked child plans are insurance
cum investment products. A part of the premium goes towards life cover
(mortality charges) and other policy charges (premium allocation,
administration, fund management etc) and the remaining is invested in funds as
per policy holder’s discretion. Invested funds provide market linked returns.
If the policy holder survives the term of the policy, the fund value is paid to
the policy holder. Taxation benefits (entire premium counts under IT section
80C), liquidity restrictions (no withdrawals allowed for 5 years) and cap on
charges are same as regular ULIPs.
Unit linked child plans are, in fact, a variant of type II
ULIPs. Under type II ULIPs, in the event of death of the policy holder, the
insurance company pays the beneficiary both sum assured and fund value. Under
type I ULIPs, in the event of death of policy holder, the insurance company
pays only the higher of sum assured and fund value.
How unit linked child plans
differ from regular ULIPs?
Under regular ULIPs, both death benefit(sum assured) and the
accumulated fund value are paid to the beneficiary upon death of the policy
holder and the policy ceases upon payment of such benefits. Under a child plan,
only the sum assured is paid to the beneficiary upon demise of the policy
holder and only the risk cover ceases. The fund value is paid to the beneficiary
only at maturity of policy. The family of the policy holder need not pay any
further premiums to the insurance company. The insurance company will pay the
entire or part of all future premiums. These premiums, like other premium
installments, will get invested and the beneficiary will receive the
accumulated fund value at maturity.
Comparison with a combination
of term plans and mutual funds
We have already established that a combination of term
plan and mutual funds gives better performance than a regular ULIP plan in a previous post. Let’s see
how a unit linked child plans
fares against this combination. We will first do a qualitative assessment of
how various product features will impact product performance.
Unit Linked Child Plan as an
insurance product
Under a unit linked child plan, maximum sum assured is capped at
a certain multiple of annual premium. Sum assured allowed under the child plan
typically varies from 10 times annual premium to 40 times annual premium for
people with age less than 45 years at the beginning of the policy. This is a
limitation as your ability to pay premium restricts your life cover. However,
your child’s future needs do not depend upon your payment ability.
Unit Linked Child Plan as an
investment product
Under unit linked plans, policy holders have multiple fund
options (equity, balanced, debt, money market) etc for parking their investment
amounts. For comparison as an investment product (with mutual funds), you need
to compare the charges because charges eat into the amount that gets invested.
There is no reason to believe that the investment returns will be higher in a
particular product. Hence, the more funds that get allocated towards
investment, the more you get in terms of maturity benefits.
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