- A custodial account allows you to open a CD for a child.
- As the custodian, you are responsible for overseeing the account until the beneficiary reaches adulthood, at which point, all assets in the account become the legal possession of the beneficiary.
- Opening a CD account for your child can be a good way to introduce them to the concept of saving and investing without assuming undue risk.
- There are alternative options available if you are looking to help your child save money in a more growth-oriented, tax-advantaged way, such as for college education or retirement.
Can You Open a Certificate of Deposit for a Child?
Yes, you can open a CD for a child. These low-risk vehicles are an excellent way to save over short to intermediate periods of time. They exhibit no volatility and offer guaranteed rates of interest, assuming deposited funds are left on deposit for a specified term —usually between one month and five years.
If your child has some money to invest (gifted or otherwise), you can open a custodial account for them and add a CD to it. When your child reaches adulthood, they will become the legal owner of the asset.
That said, know that a custodial account is irrevocable. So, once you make a deposit, you cannot withdraw it, and the child can access the money once they reach adulthood.
Laws on Custodial Accounts
The laws that underpin custodial accounts are the Uniform Gifts to Minors Act (UGMA) and the Uniform Transfers to Minors Act (UTMA).
The UGMA and UTMA are very similar. Both allow for the creation of custodial accounts on behalf of minors, and both permit minors to receive gifts and avoid the tax consequences until they reach the legal age of adulthood in their state.
The UTMA largely reflects the language of the UGMA, but it broadens the scope of the assets considered to be gifts. For most states, the UTMA has replaced the UGMA.
How To Open a CD for a Child
Opening a CD for a child is a straightforward process. The first step is finding a bank that offers custodial accounts, which is likely to be your existing bank. Once you find the right bank, follow the steps outlined below.
4 Steps To Opening a CD for a Child
- Open either a custodial UGMA or UGMT account, designating yourself as the custodian and your child as the beneficiary.
- Deposit money into the account. Generally, this can be done physically via cash or check, or electronically via an ACH or wire transfer.
- Explore the bank’s CD offering and compare the terms and annual percentage yields (APYs). Ultimately, you need to identify the instrument that best aligns with you and your child’s objectives.
- Purchase the CD and periodically monitor the balance with your child (via physical account statements or an electronic portal). The process will be a great, ongoing educational experience.
Reasons To Open a CD for Your Child
CDs are among the safest investment vehicles in which you can put your money. They exhibit zero volatility, offer guaranteed interest and, if structured properly, are fully insured up to $250,000 for individual accounts. The Federal Deposit Insurance Corporation (FDIC) insures CDs issued by banks, and the National Credit Union Administration (NCUA) insures CDs issued by credit unions.
Given their low-risk nature, CDs are an ideal instrument for novice investors wading into the world of saving and investing. Moreover, opening a custodial CD account is a smart, practical way to teach a child about personal finance. Doing so ensures you retain decision-making authority, while allowing you to include them in the process of opening the account, handling administrative matters and evaluating performance.
But if you are looking to help your child save money in a more growth-oriented, tax-advantaged way, there are better options available. This is particularly true when it comes to saving for college education and retirement.
Drawbacks To Opening a CD for Your Child
The primary drawback to opening a CD for your child is opportunity cost. Unless your child’s investment horizon is short to intermediate and noneducational in focus, there are much better, higher-yielding investment options to consider.
A secondary, related drawback pertains to taxes. The CD interest earned in a UGMA or UTMA custodial account is taxable as it accrues, which can have a meaningful drag on wealth accumulation.
Assets held in UGMA and UTMA custodial accounts are considered the named student’s assets on the Free Application for Federal Student Aid (FAFSA) form. Essentially, this means that if your child is holding a lot of money in a custodial account, it may reduce the amount of money they can receive through federal student aid.
If your child’s investment horizon is educationally oriented and long term, you should consider putting money into growth-oriented, tax-advantaged vehicles that offer higher after-tax returns than CDs. Below, you will find a few of these vehicles.
Better Options for Education Savings
If you are looking to put money aside for your child’s college education, a 529 plan is much better than a custodial CD account. It offers tax-deferred growth and tax-free withdrawals, assuming the funds put into it are used for qualified educational expenses.
There is one caveat — annual contributions are currently limited to $17,000, with a cumulative contribution cap ranging from $235,000 to $550,000, depending on the state.
Another potentially superior option to a custodial CD account is a Coverdell Education Savings Account (ESA), which can be used to pay qualified elementary, secondary and higher education expenses.
A Coverdell ESA offers the same tax advantages as a 529 plan, but the former’s contribution limits are much lower. Additionally, a Coverdell ESA is only available to families under certain income limits and only applicable to beneficiaries under the age of 18.
Better Option for Long-Term Investing
Another alternative to opening a custodial UGMA or UTMA CD account for your child is to open a custodial Roth IRA. This is a great option if your child is earning some money and wants to invest.
Contributions can be invested in various ways and earnings are tax-exempt. Investment options include stocks, bonds, alternative investments and CDs. The annual contribution limit for a Roth IRA is currently the lesser of $6,500 or the child’s earned income.
Better Option for Liquidity
The most straightforward, liquidity-enhanced alternative to a custodial CD is a high-yield savings account. Typically offered by online banks, these vehicles offer much higher interest rates than traditional savings accounts.
While a custodial CD account may offer a higher interest rate than a high-yield savings account, the money is not available to the beneficiary until they reach adulthood. A high-yield savings account, alternatively, allows for withdrawals at any time. That said, a high-yield savings account does not provide the same custodian/beneficiary guardrails as a custodial CD account.
Other Frequently Asked Questions About CDs for Children
The adult who opens the custodial account, typically a parent or legal guardian, has control over the assets held within the account until the beneficiary reaches adulthood. At this point, the beneficiary becomes the legal owner of all assets in the account.
Once you open a custodial account for a child, you cannot change the beneficiary. The child you opened the account for is entitled to the money. It cannot be transferred to another person.
To buy a CD for a child, you must do so via a bank that offers custodial accounts. While very common, not all banks offer custodial accounts.
Generally, you need the child’s legal name, date of birth, Social Security number and residential address to open a custodial account for them.
The ideal type of CD for your child depends on your primary objective. If simplicity is the priority, then a standard, zero-coupon CD with a maturity date that approximates the time until they reach adulthood. If mitigating exposure to interest-rate risk and bolstering earnings potential is the priority, then consider a CD ladder.