Child ULIPS: Are they needed for your portfolio?

Saving for the goals of our children ranks on top of the priority list of financial targets. The child ULIP (unit linked insurance plan) seeks to oversimplify the task as a single product for your child’s future.

On your own, you would build your portfolio by investing in a combination of equity and debt mutual funds, fixed deposits, bonds and a bit of gold. You would hedge life risks via a plain term insurance cover. This involves minimum fees and can be built according to your risk profile.

Child ULIP plans have a different approach. These plans provide benefits such as tax exemption and other policy-based riders. By combining investment and insurance, these products may not be the best vehicles to achieve the financial targets set for your children’s education, or other goals. Here are pros and, more importantly, the negatives that you must be aware of before investing in child ULIPs.

Are tax exemptions good enough?

With ULIP plans, you get tax deductions. The attractiveness in this head has been trimmed of late but is still relevant to the investor. ULIP premiums are exempt under Section 80C’s ₹1.5 lakh limit and so is the death benefit (Section 10(10)D). For maturity benefits, where the premium paid is more than ₹2.5 lakh per annum, tax exemption will be limited. But remember, section 80C and the ₹1.5-lakh limit compete with many other avenues: EPF, PPF, tax-saving funds, Sukanya Samriddhi and the like. The real-life exemption one can draw from ULIP will be limited, diluting the tax advantage for yearly investments.

Is return of premium really an attraction?

Amongst the features in Child ULIPs, waiver of premiums appears significant. With this feature, upon the death of the policyholder, future premiums are waived and the maturity amount is paid to the child as it would have normally. Having this feature can ease the load on term insurance payout and allow children to pursue their goals a bit more confidently, although there is no full substitute for a term insurance cover. But opting for the rider would mean higher premiums.

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Fees and charges

The returns from Child ULIP plans given on brochures are time-weighted returns. A policyholder will only realise money-weighted returns. The difference is that the fund may have generated certain returns, but the amount invested net of charges will have a bearing. The charges across policies could range from 3 per cent to 5 per cent over the policy period.

From the premium paid, a premium allocation charge will be levied, which is capped at 12.5 per cent of annual premium (one-time charge) and net will be invested as units. Units will further be levied for mortality cover (providing insurance) based on sum insured, age, and health conditions. For a life cover of ₹12 lakh, one can assume units worth ₹1,500-8,000 (depending on age and health) will be charged as mortality cover. Units for policy administration at around 1 per cent of premium, and fund management charge capped at 1.35 per cent of premium are the other significant charges.

These charges are significant lost returns when considering the last 10-year return profiles; 10 (HDFC Life Sampoorn Nivesh) - 13.2 (Tata AIA Fortune Pro) per cent for capital guarantee products or 13 (ICICI Pru Smart Kid Plan) – 19 (Tata AIA Fortune Pro) per cent in premium waiver options. Assuming 3 per cent average cumulative charges per annum compounded over 20 years (10 years premium paying period) at 12 per cent a ₹1.2 lakh gross premium per annum will return ₹47 lakh after 20 years, but could have returned ₹63 lakh if charges were 1 per cent.

Compromised insurance and investment

The life covers in these instruments are insufficient (₹10-15 lakh) and end up taking a big chunk out of investments. One can secure 10 times more through term insurance at twice the cost charged in ULIPs. Even without considering returns comparison, the investment option is also under-served by the choice of funds within the fund house and costly switching between them.

As an investor, you can save for your child’s college education and other goals via mutual funds. Charges are much lower in direct plans and you can exit funds if they underperform and move to other schemes. And mutual funds come in various categories that suit different risk appetite. Take a large enough term insurance to cover your liabilities and future goals. You will be better off skipping child ULIPs.

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