Is a CD better than a savings account for a child? (2024)

Is a CD better than a savings account for a child?

Since CDs typically earn higher annual percentage yields (APYs) than standard saving accounts, opening a CD can help your child's savings grow faster.

Certificates of deposit (CDs) are some of the safest investments available and can be an excellent way to teach children about saving and investing. You can even include your children in the process of opening and managing their CD accounts.

CDs are lower-risk, they are federally insured up to $250,000, and they may offer higher interest rates than regular savings accounts. However, other options to consider are a 529 college savings account and a Roth IRA. CDs are easy to open; most banks and credit unions offer these products.

Banks and credit unions often charge an early withdrawal penalty for taking funds from a CD ahead of its maturity date. This penalty can be a flat fee or a percentage of the interest earned. In some cases, it could even be all the interest earned, negating your efforts to use a CD for savings.

1. Early withdrawal penalty. One major drawback of a CD is that account holders can't easily access their money if an unanticipated need arises. They typically have to pay a penalty for early withdrawals, which can eat up interest and can even result in the loss of principal.

Savings accounts give you more flexibility to make withdrawals, but CDs offer fixed interest rates that can boost some savings if you're able to leave your money alone for a set time. The best place to deposit your cash generally depends on how long you're willing to leave it in your account.

CDs (Certificate of Deposit)

Long-term CDs are one of the best investments for grandchildren because they are FDIC-insured, and the return is guaranteed. So if you're investing in your child's educational future, for example, you can invest in a long-term CD and get them a higher APY.

A laser, or strong beam of light, shines on the CD while it spins. The laser beam reflects off the metallic layer of the CD. The shape of the pits in the metal creates a pattern of reflected light. The CD player or computer reads this pattern of light and turns it into a form that a person can see or hear, or both.

Can you ever lose money in a CD?

Unlike how the stock market or a Roth IRA can lose money, you typically cannot lose money in a CD. There is actually no risk the account owner incurs unless you withdraw money before the account reaches maturity.

If interest rates fall before the CD expires, the bank is out of luck and must give you the rate it quoted. If rates climb, you're stuck with the lower rate you agreed to when you opened the account. And if you take your money out before a CD matures, you'll pay a penalty -- typically three months of interest.

The FDIC Covers CDs in the Event of Bank Failure

CDs are treated by the FDIC like other bank accounts and will be insured up to $250,000 if the bank is a member of the agency. If you have multiple CDs across different member banks, each will be protected up to that limit.

The value of saving and investing money

So, if you open a CD for your children, they'll watch as meaningful growth occurs in their account. Once they see this growth for themselves, your children may be more likely to build a emergency savings and start investing earlier in their adult lives.

A child can generally have a savings account at any age. The best savings accounts for kids earn interest and have no monthly fees. A parent or guardian will likely need to open the account.

The one-third rule suggests that you should aim to save about one-third of future college costs. Like any major expense, people spread out the cost of college over time.

Certificates of deposit (CDs) could be a good option for money your child is holding in savings. CDs generally pay slightly higher interest than a savings account, in exchange for you agreeing to keep the funds in the CD until it matures.

The most popular option today is a 529 plan, which allows tax-deferred savings to be invested and used tax-free toward qualified education expenses (i.e., K-12 tuition, college tuition, room & board, books, laptops, etc.). Some states even allow a state income tax deduction for contributions to their 529 plan.

To invest $1,000 for a child's future, consider opening a brokerage account or a custodial account, or look into a 529 college savings plan with gifting options.

A certificate of deposit offers a fixed interest rate that's usually higher than what a regular savings account offers. The tradeoff is you agree to keep your money in the CD for a set amount of time, typically three months to five years.

Why would a customer want a CD rather than a savings account?

CD accounts may offer better interest rates than savings accounts. Longer terms will usually also have more favorable rates.

Even if the market crashes, your CD is still safe. Your interest rate won't change, and your money is still insured. But, keep an eye on interest rates. After your CD term ends, you might find that new CDs have lower rates if the economy is still struggling.

Penalties. This is the main disadvantage when it comes to CDs. If you need to withdraw the funds before the CD matures, you have to pay an early withdrawal penalty. The size of the penalty can vary depending on your bank, the CD term and the yield. Limited liquidity.

While CDs can provide some guaranteed returns over time and some level of security, they're not likely to provide you the returns needed to build wealth for retirement over time. Instead, it might make more sense to build wealth with other assets and only use CDs for a portion of your portfolio.

A $500 deposit into a CD with 5.5% APY would only grow to $527.50 over 12 months. But a $1,000 deposit would grow to $1,055, and a $5,000 deposit would increase to $5,275.00. That's almost $300 more earned simply by moving your money out of one account and into another. So don't wait until rates drop.