Discover how early investments, regular SIPs, and tax-efficient gifting can turn cash gifts and small monthly savings into a powerful compounding engine for your child’s schooling and college dreams.
We all think of additional expenses when we have a child. But very few of us think of additional savings. A lot of their dreams can turn into reality if we start investing for them as early as possible. If you haven’t yet taken the first step, today is the best time. Here are answers to top questions on your mind on this subject:
What Are The Ways In Which You Can Gift Mutual Fund Investments To Children?
Presently, there are quite a few ways in which you can gift:
- The first is by redirecting one-time cash gifts received for them at the time of birth, first birthday and other special occasions to mutual fund investments, instead of just letting it idle in an SB account or using it up for expenses.
- A second way is to gift mutual fund units in your name, to your children, whenever you wish to do it – typically their birthdays and during festivals. Most of us hold mutual fund units in Statement of Accounts (SoA or non-demat) format and the market regulator SEBI has recently made gifting of SoA units possible. The gift as such is tax free up to any amount (since it is done to a relative). There is also no capital gains tax on the transfer of the mutual fund units from you to your child.
- Thirdly, you can invest regularly for your children by setting up SIPs in a minor child’s name.
- A fourth way is also in the works. SEBI is considering allowing pre-paid gift cards which the recipient can in turn use to subscribe to mutual fund units.
Which Is The Best Way?
Investing regularly for your child by setting up SIPs in their name, scores over all other options. The rest of the options are either one -time or ad hoc and neither create a disciplined savings habit nor build a meaningful corpus.
Setting up a regular contribution creates an obligation to think about your child’s future from early on. Earmarking investments separately for a child and regularly topping it up also brings more discipline to your own spending as you will be compelled to increase your savings rate. You will also not be giving up or postponing your own financial goals just because you keep pulling money from your mutual fund investments to gift your child, use it for their education expenses, etc.
How Does Investing Regularly In The Child’s Name Help?
Major expenses that we foresee for a child are school and college fees. Unfortunately, education inflation each year easily runs into double digits, much higher than the general consumer price inflation (CPI). The compounding power of equity investments can prepare you to meet both school and college fees. The earlier you start, more the elbow room to fund school fees right from the initial years, through your investments. Like your SIPs for other goals, step-up SIPs each year for your child too as your income grows. Invest all other cash gifts you may receive for your child from time to time. Add a portion in lump sums whenever possible. As you keep investing through many years and market cycles, your compounding itself will be enough to take care of the fee after a point. When the child finishes school, you can use the corpus to fund college fees as well.
Here is a downloadable link to an excel calculator our team at Milestones2Wealth has built exclusively for you:
By inputting variable numbers for various factors such as annual fee, annual fee increase, monthly SIP, rate of return on investment as well as step-up SIP %, you will be able to see how you can use SIPs and the power of compounding to fund your child’s education. (We have assumed that you start SIPs as soon as your child is born and a corpus is built over the first three years of the child’s life before school fee payments begin)
Who Can Invest In A Child’s Name In Mutual Funds?
Present rules allow parents (father/mother) or, in their absence, a legal guardian to invest in a minor’s name. Often in India, culturally, many grandparents are keen to contribute towards building a corpus for their grandchildren.
If you are a grandparent, you have a few options:
- One, gifting SoA units from your MF investments as discussed earlier. But this will be suitable only for one-time or ad hoc payments and it might also eat into your retirement corpus.
- Two, few fund houses allow grandparents to use their bank accounts to invest in mutual funds in the name of the grandchild by submitting a ‘third-party’ declaration. However, this declaration should be submitted for every SIP instalment and there is also a cap of Rs 50000 per transaction. This route is restrictive and not very practical.
- Three, you can invest in your own name and make the grandchild/grandchildren the nominee. You can reinforce that the corpus is meant for your grandchild in your Will.
- The fourth route is, however, the best one to invest regularly for your grandchild – open an SB A/C in the child’s name with the parent as a guardian and set up SIPs from it. Grandparents can fund the child’s account by transferring the desired amount every month from their account as a gift. The gift is tax free as it is done to an eligible relative.
What Is The Procedure To Invest For Children?
The procedure is simple.
- Firstly, to invest in mutual funds in the name of a minor child, you don’t need a PAN or KYC for the child. Your own KYC and PAN will suffice.
- Second, while the SIP debits can even go from a parent’s SB a/c, redemption proceeds can be credited only to the minor’s a/c (where the minor is either a single holder with the parent as guardian or a joint holder with a parent). To keep the child’s investment matters separate, it is better to open an account in the child’s name and route all transactions through it.
- Apart from the bank account details, the child’s birth certificate is all that is required for proof of age as well as proof of relationship to start your investments.
Keep in mind that mutual fund holdings will be solely in the name of the minor only. No joint holdings are allowed.
What Happens When The Child Becomes A Major?
The minor’s investment account temporarily freezes when your child turns 18 (at 21 if you are the legal guardian). You will not be able to continue the SIPs or other standing instructions. The account should be regularized before any further action is taken.
The following are the requirements :
- Own PAN card and KYC of the major child
- Regular bank a/c in their own name without guardianship
- Application (Minor to major conversion form) to AMCs/mutual funds for change in status
- Fresh nomination
- Fresh mandate to continue investing
Typically, the child will still be dependent on you when she becomes a major. Once the changeover is completed, you can continue investing for your child by funding her bank a/c till she finishes college. For the child, seeing how mutual fund investments in her name from a young age have come in handy for her education expenses, is powerful. It sets the base for the child to begin early and harness the power of compounding in her life as well.
How Will The Transactions Be Taxed During The Life Cycle Of The Investment?
When the child is a minor, capital gains on redemptions gets treated as income of the parent whose annual income is higher and is taxed in his/her hands. When the child becomes a major, capital gains become taxable in the child’s hands. Until the children are not earning, they can use capital gains exemption limit on equities up to Rs 1.25 lakh as well as the child’s own income being below the basic exemption limit to their advantage, leading to lower or no tax incidence.
If you wish to start a SIP in your child’s or grandchild’s name or invest for your family goals, Enroll with Milestones2Wealth today.
