Giving birth is simple but taking care of a baby’s needs is another story. These days, to nurture and protect a baby requires a lot of money!

Nowadays everything is expensive, so how can a young couple manage their spending? I came across a young couple who told me that they need a minimum of RM10,000 monthly for basic necessities; which includes payments for two car loans and a housing loan. However, the biggest expense is having a baby. They are afraid to plan for more than one child because of the high financial commitment especially towards education. On the other hand, I have many friends who can afford to prepare education funds yet are unable to conceive. What a satire!

I guess most parents will agree that planning for education is one of the most important aspects to consider if you’re going to have children. The world is so competitive nowadays that a good education is important to give our children a chance to pursue a better life. Therefore, most parents are very concerned about education funds and will start to plan for one as early as possible.

As a parent, I drew up my children’s education fund when they were three months old after implementing a comprehensive medical plan for them. The main reason I started the education fund so early was due to the concept of compounding interest! The earlier I start, the lesser the amount I need to accumulate for the same amount of investment return.

Parents will usually look into different ways to accumulate their children’s education fund. The most common are insurance and unit trust products. Insurance plans that are suitable to serve as education plans are divided into many types and are available from insurance companies. One of the most common insurance plan is an Income Plan, a type of plan which allows you to pay for a medium term, such as six to 10 years, and you will start to enjoy income from the second year or on the sixth year or 11th year, depending on the terms and conditions. Technically, it is a modification of a deferred annuity plan. However, you are not entitled to an income-tax relief of RM3,000 under education.

I would also like to highlight to parents that insurance is not an investment product. The value of an insurance plan need to be accumulated over a period of time before it reaches the breakeven point (the surrender value equal to the total premium paid). If you stop paying half way and wish to surrender the policy, you will need to accept a surrender value of less than half of the total premium paid. Likewise, it takes years to reach the breakeven point and if your children now are age three or below, where they only need the education fund at the age of 18, the income plan may be a saving tool to save for their education fund. It applies also to endowment plans and investment linked plans.

From the financial planning perspective if your child’s age is over three years old, you can implement their education fund through a unit trust on a monthly basis, and at the same time buy a term insurance which offers the coverage of death, TPD and critical illness. The sum assured should be the amount that is equivalent to your targeted education fund and the period of coverage should be until the youngest child’s age is 25. In the event of a mishap, before the youngest child graduates, the sum assured can be used for your children’s education.

Recently, I received this case: Mr. Y will leave Malaysia for a number of years to work overseas. He does not want to trouble his family members to continue paying the insurance premium on his behalf and he decided to terminate his policy which he had bought three years ago. However, he only managed to get back 48% of the total premium that he had paid. He was very unhappy and was left wondering why he lost more than 50% in three years! He was given the impression that insurance is a very low-risk investment.

The plan that Mr. Y bought is a deferred annuity plan (commonly referred to as an income plan). The rate of return for this plan is normally 1% to 2% p.a. (average compounding interest) more than Fixed Deposit (FD), depending on the length of the policy or the age of the policy owner.

The main reason he only get back 48% of the premium paid was because his premium has been used to pay for commission, admin charges and other charges. The balance amount and the declared dividend is the surrender value. For this type of plan, the breakeven point would probably fall around the 10th year.

Once he signs up for this policy he has to commit to 10 years premium payment. Within 10 years if he surrenders the policy he will get back the accumulated surrender value that is declared by the insurance company which is normally less than what he paid in total (total premium paid in three years is RM43,000). The gap between the surrender value and the total premium paid will be narrowed if he continued to pay the premium for 10 years. Therefore, it is not surprising if he only got back RM20,000 by surrendering the policy after only three years.

Annual income is normally a guaranteed percentage (for example 5%) based on the sum assured or a guaranteed (4%) plus a non-guaranteed percentage (3%) based on the sum assured.

Interest rate is a percentage that varies from year to year, as declared by the insurance company. It is an interest on the income or dividend that was deposited or kept with the insurance company.

Compound average return is a real compounded return that takes regular payments and regular income into consideration over a long term of accumulation.

If you withdraw the income every year from your income plan, the compound average return will be lesser as compared to keeping the income with the insurance company. Normally the insurance company will give you an interest rate of 5% to 6% p.a. on the income that you deposited with them.

An income plan return has to be computed with an internal rate of return (IRR) formula to derive the compounded average return. However, a lot of policy owners make the mistake of using simple interest formula to compute the rate of return. Therefore if you were told that the average return of the income plan you bought is at least 7% on average, it was actually based on simple interest calculation. To compare this rate of return with a unit trust return which is also 7% p.a. is totally wrong, as the actual amount earned in a unit trust will be much higher than the income plan if both are based on the same percentage.

Below is a simple illustration to elaborate the differences between compounding interests and simple interests:

Return Calculated by Compounding Interest formula

• If you invest RM100,000 now for 10 years, and the return is 7.2% compound interest annually, the total investment value after 10 years will become RM200,000.

Return Calculated by Simple Interest formula

• If you invest RM100,000 now for 10 years, and the return is 7.2% average simple interest, the total investment value after 10 years will become RM 172,000 only.

Please bear in mind that for an income plan, the compound average return normally ranges from 3.5% p.a. to 5.3% p.a. for plans launched in the last three years. Historically, none of the income plans launched during the past three years offered more than 6% p.a. return.