A certificate of deposit (CD) can be a very low-risk way to save for the short-term future. If your child has some savings they’d like to invest or if you’d like to put some money aside for them, you can open a CD on their behalf using a custodial account.

Opening a CD for a child can be a great way to teach your kids about the importance and benefits of saving without exposing their money to the risks of the stock market. If you are looking to save money for college, however, there are alternative ways to do this that might be more tax- and cost-efficient in the long run.

In this article, we’ll explain why you would open a CD for your child, how you can do that, and explore a few alternatives.

Opening a Certificate of Deposit (CD) for a Child

Certificates of deposit (CDs) are some of the safest investments around. Not only is their return guaranteed by the bank, but the money in them is also insured by the federal government against loss. (Deposits are federally insured if the bank is an FDIC member or, if it’s a credit union, a member of the NCUA.)

This makes CDs a great first investment for children—a place where they can learn about the importance of saving and investing with very little risk.

It’s relatively straightforward to open a CD for your child. To do so, you can use a custodial account. This is an account that a custodian (such as a parent) controls on behalf of a minor (a person under the age of 18 or 21 years, depending on the state). The custodian must approve all transactions for the account until the child reaches adulthood, at which point all the assets in the account pass to them.

Custodial accounts come in two basic varieties: the Uniform Transfers to Minors Act (UTMA) accounts and the older Uniform Gift to Minors Act (UGMA) accounts. Their main distinction lies in the kind of assets you can contribute to them, but you can open a CD for your child with either type of account.

To open a custodial account, you must first find a bank or brokerage that offers them. Most parents will start with their current bank. If your bank doesn’t offer custodial accounts, do a quick search online and you’ll be presented with plenty of options. Opening a custodial account is a similar process to opening a standard bank account, but you’ll also provide your child’s details.

Be aware that once you open a custodial account for a child, you can’t change the beneficiary. This means the child you opened the account for is entitled to the money and you can’t transfer the account to another child. So, if you have three children and you want to open CDs for each of them, you’ll need three different custodial accounts. 

The final step is to add CDs to the custodial account. If you opened a custodial account with a bank or brokerage, log into their online banking portal to explore your CD options. Taking out a CD, from this point, is simply a matter of selecting the one that best suits your child.

Depending on your child’s age, you may want to involve them in some parts of this process. Taking out a short-term CD (three months, say) can be a good way to explain basic investing concepts to children and teach them the importance of financial discipline. If you want to put money aside for their future, especially to pay for college, there are some other investment options that might be more effective.

Alternatives to a CD for a Child

While CDs offer a low-risk way to save for short-term goals, they are not so effective when it comes to saving for your child’s long-term future. If you want to start saving money to send your children to college, for instance, a CD might not be the best way to do that.

This is for several reasons. One is that assets held in UGMA and UTMA accounts are considered the student’s assets on the Free Application for Federal Student Aid (FAFSA). This means that if your child is holding a lot of money in a CD in a custodial account, it may reduce the amount of money they can receive in federal student aid.

Holding the same amount of money in a 529 plan or a Coverdell Education Savings Account (ESA) might allow your child to access more aid. A 529 plan is the standard choice for parents who want to save money for education expenses, partially because of the tax-deferred growth and tax-free withdrawals these plans offer. You typically can’t buy a CD in a 529 plan, but you can roll some CDs into them.

Another alternative is a Roth IRA for kids. This can be a good option if your children are earning money and want to invest it for the long-term future. Contributions to these accounts can grow tax-free, but they can’t exceed the amount the child has earned in a year. There are also annual contribution limits—for 2022, the annual IRA contribution limit is $6,000. FDIC-insured CDs are among the many investment choices a Roth IRA account may accept.

The Bottom Line

You can open a certificate of deposit (CD) for your child using a custodial account. You can open a custodial account online and then add CDs to it on behalf of your child. Because CDs are such low-risk investments, they can be a good tool to teach children about the importance of saving and investing.

If you are looking to put money aside for your child’s college education, however, a CD might not be the best way to do that. A 529 account offers tax-deferred growth and tax-free withdrawals as long as the funds in it are used for educational expenses. Your child’s earnings from a CD, in contrast, will be taxed as income.