Starting a mutual fund for your child no longer requires the cumbersome process of opening a bank account in their name. According to a recent circular released by the Securities Exchange Board of India (Sebi) on May 12, 2023, investments can now also be made from the bank account of the parent or legal guardian of the minor, or a joint account of the minor with a parent or legal guardian. This new rule will be effective from June 15, 2023.
The recent change in rules is a positive development as it simplifies the investment process. Moreover, having a mutual fund in a child’s name provides a stronger sense of commitment for parents to continue the investment. On the other hand, if the investment is in an individual’s name, there is a higher probability of withdrawals during emergencies, for purchasing luxury items like the iPhone 14 Pro, or during market downturns.
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However, it’s important to note that the redemption proceeds of the investment will still be credited to the minor’s bank account exclusively when funds are withdrawn. This means you might not have a bank account in the name of the child while opening a MF scheme but you will need the one at the time of withdrawing the amount with complete KYC formalities.
“A parent or legal guardian can invest in mutual funds in a minor’s name. But investments in a minor’s name will not have joint owners. The child is the first and sole holder of such an investment. After he/she turns 18, the minor could operate the mutual fund account on his/her own. Till now, all investments had to be made through a bank account in the child’s name. Last week, SEBI changed the rule to allow investments from the bank account of the parent or legal guardian,” said Raj Khosla Founder and MD – MyMoneyMantra.com.
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Therefore, it is important to consider that once your child reaches the age of 18, they will become the sole owner of the investment, and you will not have any control over the funds. There is a risk that the money may be spent on something other than education, for which it was originally intended.
Another point to keep in mind is the taxability of gains from such investments. “There are two aspects of it. If the investment is withdrawn before the child turns 18 then the capital gain becomes taxable in the hands of the parent under clubbing provisions of the Income Tax Act. If the investment is redeemed after 18 years of age, then in this case capital gains can be taxed in the hands of children provided the original investment is considered as a gift from the parent,” explained Sujit Bangar – Founder – TaxBuddy.com.
Jay Thacker, Member, Association of Registered Investment Advisors (ARIA) said, “Understand the tax implications of income generated from investments in the child’s name, throughout the investment tenure. Moreover, prepare and submit KYC documents to the concerned point of contact well in time, as the child turns major to ensure smooth continuity of MF SIPs. This will ensure continuity and transfer of investments to the child’s name when they reach the legal age.”
Previously, in a December 2019 circular, SEBI had mandated that mutual fund investments in the name of the minor could only be accepted from the minor’s bank account or from a joint account with the guardian. This amendment has now been reversed by SEBI on the recommendation of the Mutual Fund Advisory Committee.
Hence, if you want to start a mutual fund in your child’s name, here are a few tips on how to select the right scheme.
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First things first. When investing for a child’s education, it’s important to typically consider the time horizon and risk tolerance of the parent. Then you need to invest in funds that have given stable returns over the years and don’t get lured by seeing the short-term performance.
“The choice of the fund category depends on how soon you need the money. If your child is below 8 years, then you have more than 10 years to grow the corpus. You can safely invest in a mix of large-cap, midcap and flexicap funds for the purpose. If your child is 10-14 years old, then you should go for balanced hybrid funds or dynamic asset allocation funds. The ideal asset mix in such a situation is 50 per cent in equities and 50 per cent in fixed income. If your child is over 15, you can’t take any chances with volatile investments. Go for low-risk investments, such as a debt fund or a recurring deposit. You can also consider investing in hybrid conservative funds that allocate a thin 15-20 per cent of the corpus in equities to beat inflation. Avoid long-term and illiquid investments that cannot be redeemed,” said Raj Khosla Founder and MD – MyMoneyMantra.com.
What are the documents required? Documents needed to open a mutual fund account includes proof of the child’s age and relationship with parent/guardian. This can be a birth certificate, passport or Aadhaar card and cancelled cheque of the bank account of the child/parent/legal guardian.
Last but not least, as one approaches the designated goals, says Thacker, a tapered exit investment strategy of Systematic Withdrawal Plan (SWP) option is a good option to spread your withdrawals.
