We Opened a CD for Our Children’s College Education. Here’s What to Know

My children, ages 9 and 11, are currently working to save for college, or at least contribute to a portion of their future educational expenses. Before you question my parenting credentials, getting a job was actually their idea. At the tender age of 8, my son declared his goal to act in a movie produced by Marvel Studios, and his younger sister followed his lead.

While a plum role in a Marvel movie has yet to materialize, they’ve landed a number of film and commercial roles over the past two years. As of now, they’re on board with saving the majority of their earnings for college because what else do tween actors do with money? There are only so many toy ponies or video games a child needs.

Two years ago, my husband and I opened high-yield custodial savings accounts in their names when a 2% annual percentage yield was all the rage. (Now you can find APYs more than double that amount -- how times have changed!) As parents, we oversee the account until it transfers to them when they reach adulthood (the legal age varies between 18 and 21 by state and the type of account established). 

Once my children had sizable balances in their savings accounts, we decided to move a portion of that money into a fixed-rate certificate of deposit, or CD account. We did this to lock in a high-yield APY in the current elevated-rate environment. Although their savings balances were growing at a satisfying rate, APYs on savings accounts are variable and can change at any time. We decided to go with a CD ladder strategy, opening nine- and 18-month CDs since those terms offered the highest APYs at our bank. (More on earning higher returns with the CD ladder strategy below.)

Is a CD the best option to save for a child’s college education? Read on to learn more about this savings option, how to open a custodial account and other investment account options for your kids’ future.

What is a CD for a child?

A CD is a timed deposit account that pays a fixed interest rate in exchange for leaving the money in place for a predefined period or term. A CD’s term typically ranges from six months to five years. As long as you don’t touch your money before the term expires, you’ll earn a guaranteed return on your savings. If you withdraw money before the CD reaches maturity, you’ll generally pay an early withdrawal penalty, forfeiting anywhere from 90 to 365 days’ worth of interest depending on the CD’s term.

CDs are a safe place to store savings. Because they’re federally insured at financial institutions that are FDIC members (Federal Deposit Insurance Agency), accounts are guaranteed against loss up to $250,000 per person, per institution.

To open a CD for your child, you’ll need to first open a custodial account under either the Uniform Transfer to Minors Act (UTMA) or the Uniform Gifts to Minors Act (UGMA). Both accounts can transfer financial assets -- such as cash or securities -- to minor children without the hassle or expense that comes with setting up and managing trust accounts. The main difference between the two accounts is that UTMA accounts allow you to gift additional financial assets to minors such as real estate or royalties.

The first step is to locate a bank, credit union or brokerage that offers a custodial CD account. Some banks provide UTMA savings accounts but not CDs for minors. If your bank doesn’t offer a custodial CD account, review this list of CNET’s top-yielding CDs.

Reasons to open a CD for your child

Your kids may not be sharpening their acting chops like mine, but you probably share my concern about the cost of a college education: The average public college tuition has more than doubled since 2000. 

Adding CDs to your family’s portfolio can be a viable part of your savings strategy, particularly as a low-risk and reliable method that guarantees growth over time, said Jason Ball, CFP and financial planner. “But like every financial instrument, a CD has its strengths and weaknesses,” Ball said.

If you’re considering opening a CD account to save for your child’s future college expenses, time is your ally. Getting started as soon as possible will help you achieve the largest return on your educational savings. Ball explained that CDs are an attractive college saving option for the following reasons: 

Guaranteed returns. CDs have a fixed interest rate, guaranteeing your investment’s safety and growth, while providing peace of mind when saving for future education costs.

Federally insured protections. CDs from financial institutions that are FDIC- or NCUA-insured are covered against bank losses for up to $250,000 per person, per institution making them a safe harbor for your investment.

A variety of terms. With different maturity dates available, you can choose a CD that matches your family’s academic timeline.

Flexibility. There aren’t stipulations on what the money your child’s CD must be used for, so you’ll have more control over spending. That means you can fund other expenses, like an emergency plane ride home to cure first-year homesickness.

Drawbacks of opening a CD for your child

While CDs can play a role in an education savings plan, they’re not always the optimal tool on their own due to their lower returns and lack of tax benefits, Ball said. CDs may be a less attractive college savings option because of the following:

Lower returns. CDs are a low-risk way to get guaranteed returns, but typically offer lower returns compared with riskier investments such as stocks, bonds or mutual funds. 

Early withdrawal penalties. Accessing your funds before the CD reaches maturity usually incurs penalties, which can be a challenge if unexpected education costs arise.

No tax benefits. Unlike 529 plans or Education Savings Accounts, CDs don’t offer tax-free growth or withdrawals if the money is used for educational expenses. The interest earned is subject to federal income tax.

Locked interest rate. A CD locks in a fixed APY at the time of purchase. That means if market conditions cause interest rates to rise, the balance in an existing CD won’t benefit from those higher rates or additional returns.

Specialty CDs you can open for your child

If you’re considering a CD but don’t like some of the drawbacks, consider a specialty CD instead. Though they’re less widely available than traditional CDs, specialty CDs have certain advantages that can increase flexibility and earnings. 

• No-penalty CD: A no-penalty CD has a fixed term and earns an APY that could be higher than a regular savings account, and you’re allowed to access your money before the term is up. But the rates are slightly lower than high-yield CDs that come with early withdrawal penalties. 

• Step-up CD: A step-up CD earns an APY that increases incrementally according to a predefined schedule within the term. The schedules and rate increases vary among banks and credit unions. 

• Bump-up CD: A bump-up CD generally permits an interest rate adjustment if the financial institution’s rate changes. In this case, you, as the account custodian, must request the rate adjustment, and you’re limited to one change per term.

• Brokered CD: A brokered CD is a collection of CDs issued by banks or credit unions and sold in bulk to brokerages and investment firms. The investments are then resold to individual investors on a secondary market, similar to the way bonds are issued and sold. Brokered CDs generally have higher rates than traditional CDs and can be sold on the secondary market to access your funds without incurring early withdrawal fees.

• CD ladder: A CD ladder savings approach includes opening multiple CDs with different maturity dates. When the shorter-term CD expires, you can capitalize on any rate increases and reinvest that money into a longer-term CD with a higher APY. 

How to open a CD for your child

Opening a custodial account is a straightforward process but can require multiple steps outside of the normal bank account opening process. First, you’ll need to identify a bank, credit union or brokerage firm that offers custodial CD accounts. In some cases, you may be required to open a custodial account on your child’s behalf in person, but there are also options to open a custodial account online. 

In our case, we opened accounts at an online bank we already used that had competitive rates on CDs --  above a 5% APY on several terms. After completing the paperwork with original signatures and mailing it to the bank, it took a few days to set up the custodial accounts.

Typically, a parent or legal guardian opens a custodial CD account. Here’s how to open a CD for your child or dependent:

• Locate a financial institution that offers custodial accounts and different CD options. Compare the rates to ensure your child’s account has a high-yield APY and select a term length based on when you might need to access the money.

• Once the beneficiary, your child, has been named for the custodial CD account, it can’t be changed. If you have multiple children, you’ll want to open a separate account for each child.

• In addition to providing your own identification and contact information, you’ll also need to provide your child’s personal information. Gather their birth certificate or passport and Social Security number to open the custodial account.

• Once the custodial account has been opened, select the type of CD you’d like to open and fund the account. Traditional CDs won’t let you deposit additional funds once the CD has been opened until the CD term ends. After the maturity date passes, most traditional CDs renew automatically with a seven- to 10-day grace period that allows you to either withdraw all the money or modify the CD’s balance or term.

• Set up online banking access and connect the custodial account so you can monitor your child’s CD and make changes during the grace period if needed.

Other ways to save for your child’s college education

We’ve set up several custodial accounts for our children as part of an overall college savings strategy, including high-yield savings accounts, 529 plans and ETFs. Experts routinely suggest maintaining a diversified portfolio of investment assets to balance the risks associated with each type. 

I like the idea of adding a custodial CD account to lock in a fixed rate of growth for a portion of my children’s savings. While other account types have benefits such as tax advantages or historically higher returns, those results can fluctuate with market conditions. Speak with a financial professional to determine which of the following custodial accounts are best suited for your child’s college funding goals.

• High-yield savings account: A high-yield savings account is an interest-earning savings account often offered by online banks or online-only branches of larger banks. The best APYs available on high-yield savings accounts are at or approaching 5%.

• Money market account: A money market account is similar to a high-yield savings account. It offers a higher interest rate than your traditional savings account but has some added flexibility, such as the option to use a debit card or write checks. MMAs may restrict the number of monthly withdrawals. 

• 529 plans: A 529 plan is a tax-advantaged investment account designed to help families pay for a child’s college education. The money saved in a 529 plan will grow tax free and provide tax-free withdrawals if it’s used for approved educational expenses such as tuition or books.

• Mutual funds:  A mutual fund takes money collected from separate investors to invest in a set of securities including stocks and bonds. Mutual funds can also be gifted to a minor using a UTMA or UGMA account as a strategy to save for college. 

• Index funds and ETFs: An index fund is a collection of stocks, bonds or other securities that tracks the performance of a specific index such as the Standard & Poor’s 500-stock index. An ETF, or exchange-traded fund, is similar to a mutual fund but trades more like a stock -- meaning you can buy or sell shares of a fund at any point during the day. Index funds and ETFs allow you to diversify your investments and generally have lower fees than actively managed mutual funds. Both can be gifted to a minor and used to save for college expenses using custodial accounts.