Supporting children financially for their educational and associated needs till they start earning and become independent is a major task for all responsible parents. Assessing the future requirement and planning for it in advance will certainly make it easier. The current inflationary trends suggest that the corpus needed is significant. Any successful investment leading to the desirable figures would also entail a good proportion of tax on the returns. Apart from aiding in a focused approach, when you invest for children-in the name of children, it might give significant tax advantages at the time of redemption.

Why Invest for Children

In our cultural context, education and marriage of children are two important financial responsibilities that most parents are willing to bear. We have discussed earlier how to calculate the investment requirements in “Want to Create Wealth- How Much and by When?”.  Further the intended timelines for these objectives are generally before the children are presumably financially independent. This means that the window to utilize these investments will generally fall between the age of 18 to 23. This period of approximately five years or more is what we should plan for. And to minimise any leakage from returns in the form of taxation, it makes sense to make the corresponding investments in the name of children.

Where to Invest for Children

We can appreciate that most of us do not have bulk amounts for investments. It is from our regular income mostly in the form of salary that we make some recurring savings/investment. In this context my recommendation would be that one should invest in Mutual Funds through SIP Mode. Further there is adequate empirical evidence to suggest that Equity has the potential to give max returns. I therefore suggest that you make long term investments in Equity Mutual Funds. To have adequate diversification, one can invest in Large Cap, Mid Cap and Small Cap Funds in suitable proportions. What I certainly do not recommend is any saving in the form of Fixed deposits, or any other instrument which creates an annual tax liability. Investing in instruments like Mutual Funds helps in deferring tax. This lets you to continue earning on the amount which would have otherwise gone away as tax.

Tax Issues and Benefits of Investing in the Name of Children

Now coming to the most important factor why investing in the name of children makes more sense. As per prevailing tax laws, for taxation purposes, the income that we generate from investments in the name of spouse or children (below 18) is clubbed with that of the parent with higher income. Most people would therefore be paying taxes as per their applicable slab which is generally the highest tax slab of 30%, or as applicable for the nature of income. When we invest in the name of children, this tax liability shifts to the children when they turn 18.

As discussed earlier, the period between 18 to 23 is generally when they are studying and not earning, with almost zero tax implications. Further we can adjust the capital gains from Equity investments more than Rs 1 lakh against the basic exemption limit of ₹ 2.5 Lakh. This gives a clear opportunity to avail capital gains of ₹3.5 lakh without any tax liability in any year. The range can further increase as and when the govt raises the basic exemption limit. So, in a nutshell, by investing for children in the name of the children we can maximise our cash flows for the intended objectives at the right time.

Actions on Children Turning 18

We have seen the importance of having the required infrastructure to help us invest and benefit from financial markets in “ Are You Organised for Investing”.  It is also an important part of “Financial Grooming of our Children” that we help them in getting organised. Towards this end we can do many things well before they turn 18, but we must ensure that we complete all when they turn 18. The simple checklist is as under: –

• Aadhar No
• Bank Account
• PAN
• Demat Account
• Trading Account

It may be of interest to note that we can transfer shares as gifts to children (over 18) through offline transactions and shift tax liability on returns. The same may however not be possible for Mutual Fund Units held as portfolio. The portfolios held in the child’s name will however automatically become his/her when he/she turns 18.

Conclusion

Investing for well defined objectives pertaining to our children is a necessity. Investing in the name of children helps us in a focussed approach and provides significant tax benefits. Timely planning and careful orchestration can give optimum results and make children financially aware as they graduate in life.

Suggested Readings

 

Are You Organised for Investing

Asset Diversification- The Key to Balancing Risk and Return

Financial Grooming of our Children