A common dilemma of investors is whether they should invest in the name of their children for goals like college education.
Should you invest in the name of your children?
Posted on 20 Apr 2022
Author: Sayan Sircar
10 mins read
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A common dilemma of investors is whether they should invest in the name of their children for goals like college education.
This post deals with the operational aspects of investing for children’s goals like college education, whether in India or abroad, and goals like marriage. We will cover whether parents should invest in their name or the child’s name, taxation considerations, and other details.
You should read this post in combination with the following posts in our series on investing for children’s goals:
- Goal-based investing: How to save for children’s future
- How much will my child’s college education cost?
- Should you invest in stocks, mutual funds, PPF and Sukanya Samriddhi for children?
📚 Topics covered:
- Bank account for teaching money concepts
- Invest in the name of parents
- Invest in the name of children
- Transmission of assets to children
- Which investment saves the most tax?
- What is the best way forward?
- Special case: investing for foreign education
- Special case: Investing for children of relatives
Bank account for teaching money concepts
We will quickly get this out of the way. Many parents wish to open a bank account for their children to teach them the concepts of money, interest and savings. However, along with understanding the basics of savings, there are other important concepts that you must teach once the children become teens and can understand the significance:
- the concept of the time value of money: this will ensure that children do not invest in poor return products like insurance plans and annuities
- the benefits and perils of compound interest: while compounding creates wealth, high-interest loans taken for discretionary purchases are wealth destroyers
- credit score and credit cards: credit cards are a powerful tool to build a credit history and offer benefits. However, it is easy to get into an avoidable debt trap if you do not understand what happens if you start keeping a balance
- the concept of taxes, associated calculations and progressive (slab-wise) taxation and why investing should be goal-focused and not tax-driven
- how goal-based investing will help them fulfil all of their dreams
Invest in the name of parents
The base case for investing is the simplest one of parents investing in their accounts and then using the amount for the child’s goal. For example, for an 18-year old’s undergraduate degree, the parents can:
- start a SIP when the child is a few years old
- increase the investment over the next 16 years
- start redeeming as the college expenses start
- draw down the capital over the next four years
- pay taxes in their name whenever any asset is sold
Suppose a logical separation is needed between self goals like retirement and that of the children. In that case, you can use a separate folio number or AMC for mutual funds. For example,
- retirement goals are with AMC X in Folio X1 and X2 and AMC Y with Folio Y1 and Y2
- college goal can be in AMC X in Folio C or AMC Y with Folio D with the same funds as the retirement goal
- college goal can be in AMC Z with different funds than the other goals
This approach keeps things very simple since the parents:
- can manage the portfolio along with their other goals
- keep taxes simple since they will pay taxes
- does not require the opening of minor accounts and having a PAN card at a young age for the child
- offers maximum flexibility to manage vs other goals as priorities change
Invest in the name of children
The other case has dedicated accounts for the child:
- separate bank account for the child
- separate PPF account for both boys and girls
- Sukanya Samriddhi Yojana (SSY) account only for girls
- mutual fund portfolios that must be held singly in the child’s name (you cannot have joint folios with a child)
The investments into the accounts come from the guardian’s bank account. At the same time, any capital gains on selling stocks or mutual funds are clubbed with the guardian’s income.
For PPF, each earning member can invest up to ₹1.5L/year in PPF, irrespective of the number of PPF accounts in the family. This rule means:
- double-income families can invest a maximum of ₹3L/year in all PPF accounts, including parents and children
- single-income families can invest a maximum of ₹1.5L/year in all PPF accounts, including parents and children
- investing in Sukanya Samriddhi Yojana is capped at ₹1.5L/year per girl child up to two girl children
- the girl child is the owner of the SSY account automatically once she becomes an adult at 18 without anything extra to be done
There are some operational aspects that you must keep in mind when the child turns 18:
- apply for and get a PAN card
- the account freezes in terms of transactions as soon as the child turns 18
- the accounts must be converted from minor to major, along with KYC completion to remove the freeze
- existing SIP/STP/SWP transactions will have to be renewed with funds coming in or going to a bank account in the child’s name
- the guardian cannot perform any new transactions in the account
- similarly, bank accounts and PPF will undergo KYC validation and status change from minor to major
Transmission of assets to children
Transmission, i.e. changing the ownership of assets once the child becomes an adult, works like this:
- mutual fund units cannot be gifted or transferred. You will have to sell them, pay tax and then give your child the money to purchase MF in their name
- stocks can be gifted via off-market transaction
- money can be gifted
Gifts from parents to adult children do not incur tax. Any income post the gift from those assets like interest on bank deposits or capital gains/dividends from stocks will be in the child’s name.
Which investment saves the most tax?
To understand taxation better, we need to know that capital gains tax from the sale of mutual funds or stocks is taxed as per the original purchase date and purchase price.
For example, say the parent purchases ₹5L in stocks when the child is ten years old at ₹100/share, gifts them to the child when they are 18+ when the stock is at ₹200/share, and the child sells them later at ₹250/share. The tax will be calculated with the purchase price of ₹100/share and the purchase date, for determining long term or short term holding, as of the original date more than eight years ago.
The only way the above transaction will save tax is because the capital gain from this share sale (or from MF sale when the MFs were held in the child’s folio) if the capital gain can be offset against the basic exemption limit. To explain this, currently below ₹2.5L/year income, there is no tax due. Therefore, if the capital gain amount is below this basic limit, then there is no tax to be paid by the child.
Read more here:
- How is tax calculated on selling shares/MFs?
- How to calculate taxes from capital gains and combine them with your other income
What is the best way forward?
Our guidance here will be based on the following considerations:
- finances should be simple both from their management and taxation perspective
- there is no need to have large amounts of assets held in children’s names. For example, today’s ₹10L IIT degree will likely cost ₹40L 15 years later, and there is no need to keep such large sums in the accounts of a child
- having assets in the parent’s name provides maximum flexibility when plans change either in terms of amounts needed for education or other goals
We will mix the two approaches here. When the child is young, we will start investing in the parents’ names and open their own account and mutual fund folio when they are 14-15.
Apart from teaching purposes, there is no need to open a child bank account. However, you can open an account and keep small sums in it.
The motivation for opening the child account at 14/15 is two-fold:
- investments from this point onwards, when sold at 18 for college fees, will lead to lower capital gains tax
- a separate folio can also be used to explain the concepts of capital markets and investing to the child if you do not wish to disclose the actual numbers to the child
Parents should understand that since they are following goal-based investing for their child, their investments for a few years leading up to a big college education/marriage goal will go primarily into debt assets. Therefore, it might be more tax-efficient to invest this money in the child’s folio to take advantage of the standard tax deductions.
For the PPF account, we will follow this rule:
- there is no need to have the child’s own PPF account. If the family can invest additional within the investment limits, existing PPF accounts in the names of the adults can be used
- do not open a PPF account in the child’s name if the child is more than three years old since the withdrawal is not possible for 15 years. You should ensure that the PPF account maturity is before the goal horizon, which could be either UG or PG college fee payment date
Special case: investing for foreign education
Paying for foreign education comes under the Liberalised Remittance Scheme (LRS), which requires the bank to collect 0.5% tax at source (TCS) if the amount is above ₹7L/year. It is easier for the parent to pay this amount out of their own bank accounts since they will have to file ITR to claim this TCS amount back.
Special case: Investing for children of relatives
The simplest way to invest for any child who you are not your own, either as a lump sum or on a SIP basis, is:
- create a separate bank account or MF folio in your name
- invest the money in that account and/or folio
- once the money is needed, you should redeem the deposit or sell the units, pay the tax and then use the funds
- the funds can be used by gifting to the adult child into their account (this will be tax-free for relatives)
- you can pay the college fees to the college directly since that will not have any tax issues and will ensure that the money is used for the intended purpose
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This post titled Should you invest in the name of your children? first appeared on 20 Apr 2022 at https://arthgyaan.com
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