Can I open a CD for my 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. Opening a CD for a child can be a valuable way to introduce them to personal finance concepts, helping them learn about saving money, earning interest, and building financial security for the future.

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. UTMA accounts are a type of custodial account, which means an adult manages the assets for the benefit of a minor until the child reaches adulthood.

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 in a custodial account. The custodian, typically a parent or legal guardian, will manage the account on the child’s behalf. Once the child reaches adulthood, they become the legal owner of the account, and 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. These custodial accounts are governed by laws such as the Uniform Gifts to Minors Act (UGMA) and UTMA, providing a legal framework for managing assets for minors.

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, making the child the legal owner of the account. 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. When the child reaches adulthood, they gain full control of the account as its legal owner. If you need the money back or have concerns about their ability to manage the funds responsibly at that age, unfortunately, the assets cannot be reclaimed or restricted.

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 are considered unearned income for tax purposes and 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 being eligible for less financial aid when applying to college. Additionally, cd earnings in a custodial account are considered the child’s income and can further reduce financial aid eligibility.

When you fill out the Free Application for Federal Student Aid (FAFSA), the primary factor considered is the parents’ income. The next largest factors are both the parents’ and the student’s assets. If a UTMA account holds a significant amount of money, FAFSA will recognize that the student has considerable assets available, which can result in the student being expected to contribute a larger portion toward their education costs. In contrast, if the funds were held in a 529 plan or in the parents’ name, the expectation for the child to cover their own expenses would generally be lower. These accounts can be used to pay for qualified education expenses, including college tuition, and can help support a child’s college education.

Where to find CDs for children

There are many places where you can open a CD for your child. Nearly every bank offers CDs and allows you to open a CD account or a CD for a child through a custodial account online at many banks and credit unions. This process is convenient, enabling an adult—typically a parent or legal guardian—to set up and manage the custodial account online for the child’s benefit. The child becomes the legal owner once they reach the age of majority.

When opening a CD account, you will need to make an initial deposit to fund the CD and deposit money into the account. Once the account is funded, you can start earning interest payments. It’s important to note that you can withdraw funds from the CD, but doing so before the maturity date may result in early withdrawal penalties, such as forfeiture of interest or additional fees. The maturity date is the specific date when the CD’s term ends and you can access the funds without penalty.

When considering where to open a CD for your child, online banks have become an increasingly popular choice. They often offer higher interest rates and lower fees compared to traditional banks, making them an excellent option for maximizing your child’s savings. In addition to competitive CD rates, many online banks provide high-yield savings accounts and checking account options, giving you more flexibility and convenient financial management.

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 offering better interest rates.

CDs aim to pay more interest than traditional savings accounts because they come with more restrictions, such as fixed terms during which you agree not to withdraw money. Some CDs may include a grace period after certain account activity changes, allowing you to maintain your annual percentage yield (APY) temporarily even if you don’t meet all requirements. Details about grace periods and how interest payments are handled can usually be found on the account’s APY details page, helping you understand the interest earned and any early withdrawal penalties.

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. This amount counts as your annual contribution for gift tax purposes.

If you have two children, you can gift $15,000 to each without penalty. If you’re married, this limit doubles.

Should you exceed the $15,000 annual limit, the excess will count against your lifetime gift tax exemption.

Currently, the lifetime exemption allows you to give up to $5,600,000 in gifts beyond the annual limit, tax-free. This exemption also applies to your estate.

It’s important to note that certain accounts, such as 529 plans, Coverdell Education Savings Accounts, and Roth IRAs, have their own annual contribution limits. For example, Roth IRA annual contribution limits are based on earned income and are capped each year. These accounts also offer tax advantages, such as tax-deferred growth and tax-free withdrawals for qualified expenses, making them attractive alternatives for long-term savings for children.

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.

CDs are a low risk way to save money for your child’s savings and future financial security. They offer a safe, predictable option for building a nest egg for your child, making them ideal for conservative investors or those saving for short-term goals.

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, low-risk 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 market volatility.

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. CD earnings can be used for these major expenses, and that makes it easier to predict how much you’ll need to contribute.

Conclusion

Opening a CD for your child is a great way to get them interested in saving and to provide them with a financial advantage in life.

Just make sure to consider every aspect of opening a CD and using a UTMA before taking that plunge.