Child vs regular mutual funds: Lock-in, tax rules, exit load explained

Investing for a child’s future especially long-term goals like higher education is a top financial priority for most parents. Child mutual funds are often marketed as the ideal solution for goal-based investing with the promise of disciplined savings and long-term growth.

However, not all child mutual funds are as simple as they appear. With lock-in period and exit penalties parents must understand the fine print before investing. Here’s a clear look at how child mutual funds work, how they differ from regular mutual funds, and the risks parents should be aware of.

How child MFs differ from regular MFs

Child mutual funds typically have a lock-in period (mostly five years) or until the child turns 18, whichever is earlier, with most fund houses imposing an exit penalty of around 4 percent for withdrawals before maturity.

“This lock-in limits liquidity but helps ensure funds grow uninterrupted for education milestones like college at age 18, providing financial discipline and reducing risk from market timing, allowing investors to invest and redeem whenever they want,” says Chethan Shenoy, Executive Director & Head – Product & Research, Anand Rathi Wealth.

The biggest trade-off is liquidity. “Once your child becomes a major, redemption can only happen after updating KYC and linking their bank account. Therefore, it is better to align investments with milestone-based goals, such as higher education,” says Amit Suri, mutual fund distributor and founder of AUM Wealth, a financial services organization.

According to SEBI guidelines, children’s mutual funds in India fall under “solution-oriented children’s funds.” These funds can invest in a mix of equities, debt instruments, and other permitted securities. The fund manager decides the allocation based on the investment mandate. SEBI does not mandate any specific limits, but the primary aim is long-term capital growth to meet child-related financial goals. So, the funds are in the high-risk category. AMC websites will have information on where the fund is investing, with details on sector allocation.

The Digital Process: Opening Your Child MF Account

“A minor’s MF account can be opened online with the guardian’s KYC and contact details. In terms of documentation, a minor’s birth certificate or passport is needed as proof for date of birth in addition to the KYC documents of the guardian,” says Shubham Gupta, CFA, co-founder of Growthvine Capital, a wealth management firm.

The parent acts as guardian to fill out the application form, which must be submitted via the AMC’s website or mutual fund platforms, followed by choosing a scheme and making payments through a linked bank account.

The investments can happen from either the guardian’s bank account or the minor’s bank account; however, redemption can only happen in the minor’s bank account.

“If you are going through a distributor, such investments will happen through the NSE MF Invest Portal. You can also do it through AMC websites,” says Suri.

First, complete your KYC for yourself and the minor. Visit the AMC’s website offering the desired child fund. Select the scheme and choose the direct plan. Enter the investment amount (lump sum or SIP), provide bank/payment details, agree to mandates, and complete the transaction online. Units are allotted in the child’s name.

Child MF Lock-in Does Not Offer 80C Benefit

All income generated before the child turns 18 is clubbed with the parent’s income under Section 64(1A) of the Income Tax Act. After that, it is taxed in the child’s hands, often at a lower rate. It is clubbed with the income of the parent whose income is higher.

“Also, it is important to note that unlike other instruments that come with a lock-in, such as ELSS mutual funds, PPF, or 5-year fixed deposits, child mutual funds do not qualify for deductions under Section 80C. The lock-in is purely for goal discipline, not for tax benefits,” says Gupta.

Caution: Read The Fine Print 

Whether investing yourself or via an advisor/distributor, ensure you get the right product. Many products labeled as ‘child funds’ may not be mutual funds. Some are insurance-based products like ULIPs or other child insurance plans that can confuse investors. “These typically have higher charges and different risk-return profiles. Always confirm if the product is a pure mutual fund or an insurance/ULIP plan,” says Manish Kothari, Co-founder and CEO, ZFunds.

Parents should also be cautious of misleading marketing claims by some child mutual funds, such as ones that promise guaranteed returns in certain time periods, such as in five years, in order to attract investors. Always read the fine print carefully, as most such schemes come with minimum lock-ins (typically 5 years), exit loads up to 4 percent, and restrictions on guardian changes or partial withdrawals.

“Account control shifts to the child only after age 18 with mandatory re-KYC, and some platforms may also levy additional fees. Being aware of these details helps avoid surprises related to liquidity, costs, and redemption timelines,” says Shenoy.

So, if you value the discipline that comes with compulsory lock-in, child mutual funds are for you. Regular diversified mutual funds offer you more flexibility; however, you would have to rely on your own discipline and not redeem the investments for any other purpose.