Why you should avoid buying a child plan

Saving for children's education is one of the most important goals for the parents. It is every parent's dream to ensure that their children get to pick the best possible educational institutes or career options without any financial constraints. Other goals such as buying a home or a car can be postponed or even compromised if we do not have the required funds. However, we cannot postpone our child's education.

Hence, we have to make sure that as parents we would be financially ready to meet our child's educational expenses in future. It is important to calculate the amount of fund needed for the future education, the number of years for which cash flow is needed, and how far away we are from achieving that goal today. Planning ahead and making investments towards child's education at an early stage are the critical success factors in realizing this goal.

Parents have two options to choose from:

Option 1: Investing in child plans
Child plans are insurance policies which are either traditional policies or unit linked insurance plans. Typically, in child insurance policies one parent is specified as the policy holder and the child is specified as the nominee. If the policy holder survives the tenure of the policy, periodic payouts are made at predefined time intervals. However, in case of an unexpected death of the policy holder, the proceedings are transferred to the nominee.

Option 2: Investing in a customized diversified portfolio and a term insurance plan
In diversified portfolios an individual can invest through monthly systematic investment plan (SIPs). With the help of a financial advisor, one can select right SIPs based on risk appetite and investment horizon. In order to have adequate insurance risk coverage, parents should include the expected future cost of child's education in their total insurance calculation.  It is advisable to opt for term insurance policies which are cost efficient in comparison to traditional insurance policies or ULIPs. This option yields much better financial rewards when parents maintain financial discipline, stay invested and do not redeem money till the target date.

Comparison of both investment options:

Consider a monthly payment of Rs. 3,000 over 15 year tenure. The child plan option above is an endowment insurance policy with a policy term of 15 years. Here payments are to be made for 12 years. This provides an insurance coverage of Rs. 4,54,000 for total premium payments of Rs. 4,32,000.

On the other hand, in diversified portfolio option, one invests Rs. 2900 in portfolio and makes a payment of Rs. 100 towards term insurance coverage. This provides an insurance coverage of Rs. 6,00,000 for total premium payments of Rs. 18,000 over 15 years. The maximum benefit an individual can avail if he or she survives the policy tenure under child plan option would be Rs. 6,50,000 (assuming 6 per cent return). However, under diversified portfolio option, an individual can accumulate Rs. 12,01,964 at 10 per cent rate of return (or Rs. 14,48,783 at 12 per cent rate of return).

Conclusion
Most of the parents opt for the child plan due to the fear of lack of financial discipline and or heavy marketing by financial product companies. Parents often fear that they might redeem the investments and use the money elsewhere. This leads to sub-optimal financial decision. As illustrated in the above example, if the parents maintain financial discipline, diversified portfolio can reward them with greater benefits.

ArthaYantra.com provides personal financial advice online.

Disclaimer: The opinions expressed in this article are the personal opinions of the author. NDTV Profit is not responsible for the accuracy, completeness, suitability, or validity of any information on this article.