Know the pros and cons of investing in your child’s name

Noida-based Sameeksha Srivastava (34), too, opened a bank account in her daughter’s name right after her birth and made a lump sum investment in the Sukanya Samriddhi Yojana (SSY), a government scheme designed for girl children. The SSY account can be opened either at a bank or post office. The scheme allows you to avail tax deduction for investments up to ₹1.5 lakh under section 80C of the Income Tax Act. “We also bought a term plan, started a systemic investment plan (SIP) in mutual funds (MFs) and invested in gold monetization schemes with jewellers. The SIP, though, was started with our bank accounts," she says.

Child accounts

Opening a bank account in a child’s name is not really necessary unless the parents intend to make investments in that account, say experts. There are advantages in doing that, they add.

Since a person below the age of 18 is a minor, a bank account can only be opened along with one of the parents as the joint account holder.

So, why is it necessary for a minor to have a bank account? Nitesh Buddhadev, founder, Nimit Consultancy, says, “We have observed that clients don’t stick to their financial plans if all investments are in their own names. They redeem it for various purposes. But if the investment is in a child’s name, they will hesitate to withdraw it. Capital gains are taxed in the child’s name if the investments are redeemed after they turn 18. It helps parents reduce their tax outgo on long-term investments."

Withdrawals from MFs or interest income from fixed deposits before the child turns 18 is taxable in the hands of the parents even if these investments are in the child’s name. “It is clubbed with the income of the parent who is earning more," says Buddhadev. Such passive income of up to ₹1,500 per year is tax exempt. The exemption is limited to two children in a family.

There is one exception to this rule. “If your children earn a one-time or recurring income because of their work, special talent or expertise, it is taxed in their hands. A separate ITR (income tax return) will need to be filed in their names," says Buddhadev. Experts say this income includes earnings from advertisements and endorsements.

It is to be noted that KYC (or know your customer) norms have to be mandatorily redone when the child attains the age of 18 and the account ceases to be a joint account.

Managing gifts from relatives

Gifts in the form of cash and cheques, given during birthdays or other occasions, are another reason why parents open a bank account in their children’s names. It also comes in handy when relatives other than parents want to make investments in the child’s name. “We see people opening fixed deposits in the names of their grandchildren. This, however, does not have a tax advantage. The interest accrued is taxed in the hands of parents," says Buddhadev.

A better option is to invest in MFs or other financial products. “Relatives, under Section 56(2) of income tax Act, can transfer the amount directly to a child’s bank account without any tax implications for parents. Parents can invest this amount in mutual funds either as a lump sum or start SIPs for the long-term," Mohini Mahadevia, founder, SOLUFIN, says.

Gifts from other relatives of up to ₹50,000 a year is tax free.

Where should you invest?

Many couples invest in SSY as soon as they become parents of a girl child. “The funds, however, can be utilised better considering the long lock-in period," says Buddhadev. The SSY account comes with a lock-in period of 21 years or till the time of the girl’s marriage, whichever is earlier. Parents can withdraw up to 50% of the amount from the scheme when their daughter turns 18. “People should invest in this scheme only if other major investments are equity-linked," he adds.

Besides these investment avenues, there are child-specific plans from the insurance and mutual fund industries that are popular. Srivastava, for example, bought a unit-linked insurance plan (ULIP). “I invested in it because it will give me market-linked returns in the long run. I may be tempted to redeem the MFs if the stock market is in a downturn, but that won’t be the case with the ULIP," says Srivastava.

Experts, however, caution that it is better to stay away from such products. “It makes for great sales pitch but there are better ways to manage your investments. A simple term plan along with a combination of diversified mutual funds will suffice," says Nishant Batra, chief goal planner, Holistic Prime Wealth.

As for direct equities, one can open a demat account in the name of a minor but parents are not permitted to use the account to purchase stocks from the secondary market. “There are two ways to accumulate securities. The first is via initial public offerings (IPOs), primary issues of gold and other bonds and debentures (assuming minors are allowed to invest in the same). The second is gift (transfer) securities which can be transferred to the child’s demat account," says Mohini Mahadevia, founder, SOLUFIN.

A child can also have a trading account but is barred from entering into a contract with a stock broker to purchase or sell stocks. Such trading accounts serve the sole purpose of sale of securities which a minor has come into possession by way of investment in IPOs, inheritance, corporate action or off- market transfers, according to market regulator Sebi.

A word of caution

Remember your child will become the owner of all investments in her name when she turns 18. “What if the child squanders the money? Invest in her name only when you are comfortable giving them access to a huge chunk of money," says Batra.

There is another aspect to consider. “Not all parents will have enough surplus to build their retirement corpus and child’s future at the same time. If you fail to secure your retirement by the time the child is ready for higher education, it is better to take an education loan than endangering your retirement," says Batra.