How to Open a Certificate of Deposit (CD) for Your Child
One thing that all parents want is for their children to succeed in life. To that end, parents usually try to give their kids advantages that they didn’t have. A better education, access to better resources and learning tools, and the opportunity to participate in things like youth sports.
Many parents also want to provide their children a leg-up financially. One way to do this is to open a certificate of deposit (CD) for your child. CDs are like savings accounts but pay more interest in exchange for a promise that you won’t touch the money for a set period of time.
Learn everything you need to know about opening a CD for your child.
The Uniform Transfers to Minors Act
The first thing to learn about when trying to open any kind of financial account is the Uniform Transfers to Minors Act (UTMA). This law, adopted in 1986 allows minors to receive gifts and avoid the tax consequences of those gifts until they reach the age of legal majority, usually 18 or 21.
Under the rules of the UTMA, you make a gift to the child by giving money to a custodian, who holds the money on behalf of the child. That custodian will manage the account on the child’s behalf. Once the child reaches the age of majority, the funds will be released to them. Before they come of age, they cannot access the money in the account. However, the custodian is permitted to make payments for the child’s benefit out of the account’s funds.
UTMA accounts can be used to hold any type of asset, including stocks, bonds, mutual funds, real estate, and, of course, CDs.
Anyone can establish a UTMA for a minor. There’s no need to be related to the child receiving the gift. UTMAs simply serve as a way to structure a gift that provides a number of tax benefits.
Who Owns the Account?
One important thing to note about UTMAs is that the account is owned by the child receiving the gift. That means that gifts cannot be revoked.
When you put money in a UTMA for the benefit of your child, you cannot take it back. All of the money in a UTMA must be handed over to the child when they reach the age of majority in your state. If you need the money or think they can’t handle the full amount at that age, that’s too bad.
There are benefits and drawbacks to the fact that funds in a UTMA are owned by the child.
Lower tax rate
One major benefit is that the child is likely in a much lower tax bracket than a fully-employed adult.
Any earnings in the account will most likely be taxed at a lower rate than if the adult had kept the money.
When applying for financial aid
One drawback is that having money in a UTMA can result in the child be eligible for less financial aid when applying to college.
When you fill out the Free Application for Federal Student Aid (FAFSA), the number one factor in the calculation is the parents’ income. The next biggest factors are both the parents’ and the students’ assets. If there’s a lot of money in a UTMA, the FAFSA will note that the student has a lot of assets available to them.
They’ll be expected to pay a larger portion of their education bill. Had the money been kept in a 529 or in the parents’ name, there’d be less of an expectation for the child to pay their own way.
Where to Find CDs for Children
There are a lot of places where you can open a CD for your child. Nearly any bank offers CDs and will let you open one for your child’s benefits.
However, the best place to get a CD for your child is an online bank.
Online banks have grown in popularity in recent years for a variety of reasons. One of the main reasons they’ve become popular is their high interest rates and their low fees.
Online banks cost much less to run than physical banks. Banks with physical locations have to rent land, pay for building maintenance and utilities, hire tellers, and deal with all of the costs associated with having multiple branch offices.
Online banks can operate a single central office and manage all of the bank’s accounts from one place. That lets them hire fewer employees and take advantage of economies of scale. Online banks then pass those savings on to customers by paying more interest.
CDs aim to pay more interest than savings accounts because there are more restrictions on CDs than on savings accounts.
Still, many national banks offer CDs that pay less interest than an online bank’s savings account does. Choosing an online bank’s CD will let you get the most interest possible, leaving your child with extra cash when they gain access to the UTMA.
What About Taxes?
UTMAs provide a host of tax benefits to the child receiving the money, but there are some restrictions to be aware of.
You can give up to $15,000 to each individual per year without incurring gift taxes.
If you have two children, that means you can give $15,000 to each without penalty. If you’re married, the limit doubles.
If you want to give more than the $15,000 annual limit, you’ll start eating into your lifetime gift limit.
As of now, you may give up to $5,600,000 in gifts in excess of the annual limit, tax-free, during your lifetime. This limit also applies to your estate.
So, if during your life you give $3 million in gifts and leave a $4 million estate, only $1.4 million of the estate will be taxable. If you max out the giving limit during your lifetime, your full estate will be taxable.
Not a concern for most people
Many people will never have to worry about reaching the lifetime giving limit but might want to give more than the annual limit.
In this case, all you have to do is fill out a form with your taxes at the end of the year, providing the details of your gift. You will not owe any additional taxes for going over the annual limit, so long as you stay below the lifetime limit.
For the child, the main benefit of a UTMA is that they can avoid taxes in the majority of cases. If all of a child’s UTMAs earn less than $1,050 in interest, dividends, or other earnings, the earnings are not taxed. Any earnings between $1,050 and $2,100 are taxed at the child’s rate.
Usually, this is a very low rate because the child is not employed and has relatively little in income. Any amount over $2,100 in earnings is taxed at the parent’s rate.
If your child’s UTMA has a relatively small balance, they’ll be unlikely to ever pay taxes on it. Where they could wind up paying a lot is if their accounts are well-funded and start to earn a lot of money each year.
One thing to note is that if the custodian for a UTMA dies, the UTMA will be taxed as part of their estate. If you name yourself as the custodian of your child’s UTMA and are planning to use it to avoid estate taxes, keep this in mind.
Are CDs a Good Choice to Help Your Child Save?
Whether or not CDs are a good choice to help your child save depends on many things.
The first thing to consider is how long there is between the time you give the gift and the time the child reaches the age of majority. CDs provide consistent, safe returns, but will never make a lot of money.
If your child was just born, you might be better served putting UTMA funds in riskier investments, like stocks, so that the account can grow more quickly. If your child is a teenager you might want to use a CD so that they’ll know exactly how much money they’ll be getting, without worrying about the market dropping.
Another thing to consider is what you hope your child will do with the money. If you just want to give them a leg-up as they get started in life, you can invest the funds in a more volatile asset.
If you want them to use it for something specific like paying for a year of college or making a down payment on a house, something like a CD will make it easier to know what the account’s balance will be when the child gains control of the account. That makes it easier to predict how much you’ll need to contribute.
Opening a CD for your child is a great way to get them interested in saving and to provide them a financial advantage in life.
Just make sure to consider every aspect of opening a CD and using a UTMA before taking that plunge.