Investing in mutual funds for your kid: You should be aware of a few things before you begin

Kolkata: With cost of higher education rising fast, many are inclined to invest in mutual fund schemes designed for children. As the name suggested, children's mutual fund schemes are specialised, goal-oriented hybrid instruments which can enable one to build a cool corpus for future expenses such as higher education and/or marriage or using as seed money to set up a small business. Since these encourage long-term investments, the usually carry a five-year lock-in period or until the child turns 18.

Investing in mutual funds for children is fairly simple. A parent or a legal guardian has to open a minor account in which he/she is the custodian. For the mechanicals, a few basic documents are needed for KYC -- the kid's birth certificate for proof of age and that for establishing relation with the adult who opened the minor account. Usually a SIP has to be opened and the guardian has to manage it till the kid becomes an adult.

According to the rules, all asset management companies allow opening of investment accounts in the names of a minor. The point to remember is that the child has to be the sole holder of the account. The rules don't allow any joint holder in these accounts. The guardian has to be a parent or he/she can be a legal guardian who has been appointed by a court of law. This guardian -- natural or court-appointed -- has to manage it as long as the child remains a minor. All the transactions be it SIP or lumpsum investments, or redemptions or systematic transfer plans or switches, have to be carried out in the kid's account during the pendency of the kid's account. Then after 18, the kid (now an adult) takes control of the account.

Though personal finance investors always harp on the benefits of long-term approach to investing in mutual funds in particular, many investors do not have the financial discipline and can redeem units to spend in other purposes. Therefore, the lock-in period for children funds help in keeping the money for a minimum of five years. Thus a children's account can be a special benefit.

This will continue until the kid turns an adult. At this juncture, the running systematic investment plans and systematic transfer plans will be suspended temporarily. The guardian can no longer operate the account starting from the date the child turns 18.

Now the holder of the account has to submit an application in writing stating that he/she has turned into an adult and that he/she will be in charge of the account. the person has to submit KYC documents to substantiate the claim of adulthood.

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Here is a significant point. "It might so happen that the units -- all of its or in parts -- are redeemed before the account holder turns into an adult. In that case, the gains arising out of the redemption has to be added to the taxable income of the parent or legal guardian. Then it should suffer taxes at the rate applicable to the overall income of the adult guardian or parent," said Nilanjan De, personal finance strategist and director Wishlist Capital.

Once the kid turns into an adult, the rules treat them as separate taxable individuals and the same taxation rules are applied. However, it is unlikely that a 18-year old has an income of his/her own that falls in the taxable bracket. In that case, the investments become tax efficient since they won't have to pay any tax -- the basic exemption limit of Rs 3 lakh in the new tax regime will help them in this matter. Also LTCG is available for equity mutual fund schemes. However, one can also continue or even step up the investments that have been done in one's minor years and reap the benefits of really long-term benefits of compounding.