How much should I save for my child?

Ernakulam-based A. Azad, 58, who used to work as an engineer in West Asia, had to sell some land he had in Delhi and dip into savings to meet his children’s needs. “For our son Ismail’s education, we had to sell our land in Delhi. And for our daughter, Ilham’s higher education (on part-scholarship), we used some of our retirement money. She studied in a British school, and it was difficult for her to get admission in a college in Kerala. So, she went to England,” said Azad. IIham has completed her engineering course and is now looking for a job.

Azad has a Master’s degree in Business Administration and is well versed with the basic principles of financial planning. But he didn’t use this to plan better for his children. Even for their marriage, he plans to sell some of the land that they have in Kerala.

Children’s needs are among the most important and mostly non-negotiable financial goals. But if you don’t start planning when they are young (or even earlier), you will be forced to dip into other savings. But how much to save, and for what? The answers are a matter of making accurate assumptions and calculating from there. Here’s how.

What to save for

Try to think of all the expenses that have to be met, and then separate them into immediate, short-term and long-term. In the immediate category would be building a safety net for your child so that her future is protected even if you are not around. For this ensure an adequate insurance cover and an emergency fund. As soon as your child is born, include her in your health insurance plan. “It is critical to get the child’s name included in the medical insurance cover as soon as permissible,” said Vishal Dhawan, a Mumbai-based financial planner. Get a health cover if you don’t already have one. Also, make sure that you have a life cover that is big enough to take care of your family’s financial needs. Buying a term plan of 10 times your annual income is the easiest way to do this. The next item is to build an emergency fund, which can be used in case of unforeseen events such as job loss or illness. This should have at least six months’ expenses, including child-care needs.

Once the safety net is in place, you can now focus on the short-term and long-term expenses.

Go through your cash flows and see where you can tweak it. Give yourself at least a couple of months to get the right picture. “You will have to take a relook at your expenses and income. With a new member in the family, you will have extra expenses. In case the partner decides to take a break from work, you will have to factor in that too. Hence, it is important to budget,” said Deepali Sen, a Mumbai-based certified financial planner. Also keep in mind that the amount you will need for child-care will change every year.

In the initial years, say, till the child is 3 years old, most expenses are around medical needs and child-care products. You may spend 4,000-8,000 a month in the early years. This will depend on your city and your lifestyle.

The next near-term expense is likely to be pre-school. Education is the most drawn out need as it starts when the child is just a few years old and continues till at least higher education. According to a survey by Assocham Social Development Foundation (ASDF), school expenses for a single child have gone up from 55,000 per annum in 2005 to 1.25 lakh in 2015. More than 70% parents surveyed also said they spent 30-40% of their take-home pay on child’s education. The survey stated that annual fees for a pre-school could be in the range of 35,000-75,000 a term in some cities.

While you are getting an estimate of how much you will need for early years of education, simultaneously enhance your emergency fund to cater to at least basic school fees. Check for gaps between the admission fees and your savings at least six months before she goes to school. “While you budget for your day to day expenses, start investing for your child’s long-term expenses because the ones that will come later, need bigger amounts,” said Sen.

This brings us to the crucial question of how much to save.

How to estimate

When it comes to saving for your children there are two major long-term goals—higher education and marriage. The quantum of money for both is usually large. So, the earlier you start, the lesser will be the amount you will need to invest on a monthly basis.

You need to know at least a ballpark amount which will be needed 15-20 years later. To know the future cost, there are three broad components to factor in—current cost, number of years you have to invest, and most importantly, inflation.

Let’s start with saving for higher education. While it may be difficult to predict now what your child will want to study in college, you could look at the current cost of some courses. For instance, an MBA from a premium B-school in India can cost 16-25 lakh. Studying abroad will be more expensive.

Next look at the number of years you have to invest. Say, you start planning when the child is 1 year old. That means you have 17-20 years to build your corpus. If your child is 10 years old, you have 7-10 years left.

And lastly, factor in inflation. In a long-term goal, inflation can play a spoiler. To give you an example, in the year 2000, a litre of milk used to cost 10-15; now it costs 50-70—a rise of 10-12% per year in 16 years. Though you may not be able to predict the exact level of inflation, do your calculations based on historical data. “When we do a future value calculation, we factor in 8-10% as inflation,” said Suresh Sadagopan, a Mumbai-based financial planner.

By factoring in the current cost, inflation and tenor, you can arrive at the future cost. To understand how much you need to invest every month to build the corpus, figure out how much returns you expect your investments to give. “Being a long-term goal, investing in equity mutual funds should be preferred. Though equity funds have given returns of over 15% and even 22% for over 10-year horizons, for calculation purposes, we can assume 12% returns,” said Sadagopan. Once you factor in the returns and the final cost, you will know how much to save every month.

Tools to use

If you want to get a tangible number for your goal, you can either use Microsoft Excel (see table: How to calculate future cost of education), or apps such as TVM and Future Value of Your Money. Once you download the app, just enter the components such as current cost, tenor and inflation, and you will get the future cost. Free calculators are also available online. If you still find it difficult to understand the math, you could seek professional help too.

Tania Kishore Jaleel also contributed to this story.