Financial Planning : Child Education

During my interactions with many parents, the main topic of discussion was their desire to learn how to plan and finance their children’s education. Even a few had done some self-directed planning; however, it lacked basic concepts such as goal setting for the required amount, factoring in inflation, and considering risk contingencies. A lot of parents have been misguided by their so-called advisor into buying products which were not in line with results.

Recognizing how deeply parents care about their children’s education, health, growth, and personal aspirations, I’ve aimed to develop a framework for constructive discussion. This framework doesn’t prescribe “correct” answers, but rather fosters informed decisions and positive choices that align with each child’s unique path and evolving needs.

Lets See the Framework :

Start Early:

The earlier you begin, the more time your money has to grow through compound interest. Even small contributions made consistently can add up significantly over time.

Set SMART Goals:

Define specific, measurable, achievable, relevant, and time-bound goals for your child’s education. Consider factors like desired type of institution, estimated costs, and potential scholarships or grants.

Inflation in Education:

A measurable number so as to understand the future cost of the education.

Explore Investment Options:

Research various investment options suitable for your risk tolerance and time horizon. Consider age-appropriate mutual funds, savings bonds, or guaranteed education plans (depending on local regulations).

Prioritize Diversification:

Don’t put all your eggs in one basket! Spread your investments across different asset classes (stocks, bonds, real estate) to mitigate risk and maximize potential returns.

Budget Conservatively:

Factor in not just tuition fees but also living expenses, books, and other associated costs. Create a realistic budget and stick to it, leaving room for unexpected expenses.

Utilize Government Benefits:

Research and take advantage of any government grants, scholarships, or tax breaks available for education expenses. These can significantly reduce your financial burden.

Seek Professional Guidance:

Consider consulting a financial advisor for personalized advice based on your specific circumstances and risk tolerance. A professional can help you develop a tailored financial plan and navigate complex investment options.( This is were people ignore )

Communicate with your Child:

Discuss your financial plan with your child in an age-appropriate way. This fosters transparency, teaches them the value of saving, and encourages responsible financial habits.

Let’s see how the framework works in practice using the example of Mr. and Mrs. Sharma, both MBAs who met during their studies and married around the age of 28. They became parents at 30 and both have good-paying jobs. An article about rising education costs by 10% for higher education caught their attention. This fueled their concerns, as their own MBAs cost around Rs. 11 lakhs each back then, and they already pay Rs. 2,50,000 annually for their child’s education. Seeking guidance, they consulted professionals and found solutions using the framework.

Seek Professional Guidance:

First great step they took was to seek help from professionals, rather than planning on their own. As you will see the benefits and pitfall explained to them.

SMART GOALS

As both engineers with MBAs, Mr. and Mrs. Sharma searched for engineering programs at top institutions. They found that the four-year degree course at IIT cost around Rs. 9,00,000, while VITS/Bits Pilani charged around Rs. 15,00,000. This further worried them, as the current cost of an MBA at IIMs stood at Rs. 24,00,000 lakhs.

Inflation in Education :

After researching historical inflation data, we found a CAGR of 5% over the past decade, rather than the 10% mentioned in the article. We will use this as the base inflation rate for our calculations.

At age 18, the cost of their child’s engineering education will be Rs. 32,74,311.To pursue their MBA at age 24, the estimated cost will be Rs. 70,20,625. These expenses will require a total of Rs. 1,02,94,937 from their savings.

Explore Investment Options:

Government Scheme :

Sukanya Samriddhi Yojana: A Government Scheme for Girl Child Savings

Launched in 2015 by the Government of India, Sukanya Samriddhi Yojana is a tax-saving scheme designed to encourage parents to save for their daughter’s education and marriage. Here are the key features:

• Eligibility: The account can be opened for a girl child between the age of 0 and 10 years.
• Account Opening: Parents or guardians of the girl child can open the account.
• Deposits: The minimum monthly deposit is ₹250, with a maximum annual deposit of ₹5 lakh.
• Interest: The scheme offers a fixed interest rate of 8% compounded annually.
• Tax Benefits: The interest earned is exempt from income tax under Section 80C of the Income Tax Act.
• Maturity: The account matures after 21 years from the date of opening.
• Returns: This scheme can potentially help you accumulate up to Rs 67,34,534 for your daughter’s future needs.

Investment Considerations for Mrs. and Mr. Sharma

Since Mrs. and Mr. Sharma have a son, the Sukanya Samriddhi Yojana is not applicable. However, here are some alternative options to consider:

• Insurance Planning:

• It’s crucial to protect your investment plan. The unexpected loss of an income earner can disrupt family finances. Adequate term life insurance coverage, at least Rs 1 crore for both earning parents combined, can help secure your commitments like education expenses for your son.

For our case example, they should have cover of at least Rs 1 Cr term cover between both the earning parents.

Guaranteed plans :

Till date , guaranteed plans were market favorites. However, to ensure you make informed decisions, I want to analyze their effectiveness in beating inflation and achieving your goals.

Taking three top private plans as examples (without naming companies), let’s assume parents invest Rs. 3,00,000 annually to build a corpus.

These plans offer the following benefits:

• Tax-free premiums under Section 80C
• Insurance cover, as discussed earlier
• Tax-free returns, provided the insurance premium is less than Rs. 2,50,000 per year

The next step is to assess these plans further. Can they truly keep pace with inflation and fulfill your specific needs? Stay tuned for a thorough analysis!

Plan 1 ( Endowment plan 1) :

Financial advisors recommend an investment plan to Mrs. and Mrs. Sharma. The plan involves an annual investment of Rs 300,000 for 12 years. This translates to a total investment of Rs 36,87,762 (including taxes) over the 12-year period. However, there is an 8-year waiting period before maturity.

Maturity Benefit Falls Short of Target

The guaranteed maturity amount is Rs 84,03,507, which falls short of Mrs. and Mrs. Sharma’s overall financial goals.

Life Insurance Coverage Also Insufficient

The plan also offers Rs 30,00,000 in life insurance coverage. Unfortunately, this amount may not be sufficient to fully cover their educational needs.

Alternative Investment Options to Consider

Given the shortfall in both the maturity benefit and life insurance coverage, exploring alternative investment options might be more suitable for Mrs. and Mrs. Sharma.

The worst part was when we calculated the return it was just 6.06%

Plan 2 ( Endowment plan 2)

Mrs. and Mr. Sharma were presented with another plan from a different insurer. This plan requires an annual investment of Rs 300,000 for 10 years, followed by a 6-year waiting period before receiving returns. The total investment, including taxes, would amount to Rs 30,74,259.

Lower Maturity Benefit and Investment Return

Unfortunately, the guaranteed maturity benefit of Rs 57,94,266 falls short of their financial needs. Additionally, the investment return is only 6.06%, which may not be ideal.

Higher Life Insurance Coverage

However, the plan offers a significant advantage in terms of life insurance coverage. The coverage ranges from Rs 45,00,000 to Rs 66,00,000, potentially addressing their educational needs to a greater extent.

Plan 3 ( Endowment plan 3)

Another company presented a plan with similarities to Plan 2. This plan requires an investment of Rs 338,100 annually for 10 years, followed by a 6-year holding period before receiving returns. The total investment, including taxes, would be Rs 33,81,000.

Similar Drawbacks: Low Return and Insufficient Maturity Benefit

Similar to the previous plan, the guaranteed maturity benefit of Rs 55,56,870 falls short of their overall financial goals. Additionally, the investment return is a mere 4.96%, which might not be attractive.

Higher Life Insurance Coverage, Yet Shortfall Remains

While the life insurance coverage improves, ranging from Rs 48,00,000 to Rs 71,00,000, it still may not fully address their educational needs.

Plan 4 ( Endowment plan 4)

PLAN 5

This plan focuses on separating investment and insurance for optimal growth. We purchase a separate Rs 150,000 insurance policy and invest the remaining Rs 270,000 annually. This approach results in Rs 10,097,293 at the end, bringing you close to your target goal while providing sufficient coverage and the potential for an 11.35%* return.

After analyzing various options, we found that guaranteed plans aren’t suitable for wealth growth. Therefore, it’s recommended to keep investments and insurance separate. As a result, neither insurance nor investments combined would adequately fulfill your insurance needs or foster significant financial growth.

Fixed Deposit

To ensure your financial goals aren’t derailed by unexpected situations, consider building an emergency fund equivalent to 12 months of your salary. This readily available reserve, ideally in easily accessible fixed deposits or debt funds, will protect your investments from being disrupted in times of need. With a monthly salary of Rs. 1 lakh, maintaining an emergency fund of at least Rs. 12 lakh is recommended. Regularly review and adjust this amount based on changes in your life circumstances. These readily accessible funds offer peace of mind, knowing you can handle unforeseen expenses without impacting your long-term financial goals.

Diversification :

We can diversify our portfolio with a 10% allocation to gold, adding a hedge against market downturns and inflation. This can be achieved through SGBs, gold

*The return is not guaranteed but is based on past returns of SIP which may or may not be applicable in the future.

ETF SIPs, or digital gold. While potential long-term growth for gold may range around 4-7%, its stable returns compared to some volatile assets can enhance overall portfolio stability.

While the options mentioned offer flexibility, it’s always advisable to review your financial plan with your advisor regularly. This ensures you’re on the right track and can make necessary adjustments, including reevaluating asset allocation and profit booking strategies.

Remember, not all financial products are created equal. As discussed earlier, some might not align with your long-term goals and should be reconsidered.

Adhering to asset allocation principles based on your risk profile and timeline is essential for successful financial planning. There’s no one-size-fits-all approach, but consulting a financial advisor allows you to tailor, review, update, and adapt your plan as your financial circumstances evolve.

You can watch our video for the same