Allowances for Children

Age 5 is a common age when parents start thinking about issuing an allowance to children.   The goal with an allowance is to teach children about personal finance and delayed gratification.  Children who practice delayed gratification tend to be more successful in life.  Thankfully, this is a skill that can be acquired with practice. You may choose to tie the allowance to chores, or not.  There are two schools of thought on the topic, which you can read about here.  Personally, I thought everyone tied the allowance to chores but after researching this article, I am considering the alternative.  There are certain things that children need to learn to do for personal hygiene or to be considerate while living with others.  If they don't do these things, taking away an allowance may not be enough to motivate them, leaving the chores undone.  Rather, you can take away things like attending a birthday party or the car keys if they don't do these basic requirements of being a family member.  An allowance can be seen more as a way to allow children to learn from their money choices and make mistakes now, versus when they are 18 or older.

Experts vary on the amount of allowance to give, but a formula based on age per week (say 50 cents or $1 per age) is simple, and easy to follow, even as they get older.  Some parents issue allowance monthly versus weekly, or round to the nearest dollar so they don't have to worry about the change.  Choose a system that you can realistically afford and maintain over the long-term.

We use the Jar System in our household.  It consists of 3 jars: Charity, Savings, and Spending.  A child splits her allowance into each jar by the following percentages: 10% to charity, 40% to savings and 50% to spending.

Charity Jar

This can go towards a charity that interests the child, such as an animal shelter or place of worship.   My daughter used to attend a school that allowed a different charity to solicit money from the children virtually every week.  They would tell the children that if they donated $5 or $10, they would get some knick-knack.  My daughter got very frustrated with me for not giving her the money, but I told her we already donate all we can afford to the charities we most care about and have researched.   She started giving money from her charity jar.  The first time, she emptied her jar completely on one charity.  The next week, another charity came that she would have preferred to give to, but she had no money left.  She is learning to be more thoughtful about who she is giving to and why, and she tries not to completely empty her charity jar on any one cause.

Spending Jar

This can go to any immediate wants.  Examples in our household include gum or mints, which I don't typically purchase for the children.  It is so nice to be in a grocery store or Target and just say "You don't need that, so you can buy that with your money if you want."  It prevents anyone from getting emotional, and clarifies the way things work: We, the parents, will provide your needs and a small allowance, and you get to choose how to spend that allowance.  We need to be in control of our budget, just like you.

Savings Jar

You can put this money in a bank account for them or add 2 cents for every dollar they have in their jar at the end of the month.  This will teach them about "compound interest", where they earn money on the savings, not just what was put into the jar originally. You can let them dip into this savings at their discretion or require they save it for long-term expenses like college or a car.

Interested in books for children about personal finance?  I read all of these books and can personally recommend them.

Trouble With Money

The Rag Coat

Alexander, Who Used to be Rich Last Sunday

A Smart Girl's Guide: Money

Lemonade in Winter

Personal Finance For Children

When it is relevant for a client, PWR financial plans include a section on personal finance for children.  We compile information from a few sources including Money as You Grow.

Here are some age appropriate activities I started doing with my 3 1/2 year old.

1)  Identify what costs money versus what is free.  For example, we pay money when we go to the local pool.  We don't pay money when we go to the library, park or the beach.  Those are free activities.

2)  Explain that people can get money by working.  Mommy and Daddy go to work to get money.  A couple of neighborhood kids were selling snow cones one day - they were working too!

3)  There is a difference between what we need versus what we want.  We need to buy fruits and vegetables at the store or farmer's market.  We don't need to buy lollipops and cookies.  Those are special treats we get every once in a while.  We need a place to live and a car to drive, but we don't need an automatic bubble maker (yes - these exist!) or a new scooter.  Those things are nice to have, and we may want and enjoy them, but we don't need them.

Use these examples or create your own using the Money as You Grow site as a start.

Using a 529 Plan to Help a Grandchild Pay for College

When grandparents want to help pay for a grandchild’s education, they can choose a method that is just as beneficial to them as it is to their grandchild. With smart planning, grandparents can save taxes using a tax-preferred vehicle like a 529 plan. If they choose a 529 plan, it is important to understand the implications of having grandparents as owners instead of the child’s parents. Tax-deferred 529 plans have an account owner and a beneficiary. Typically, a parent is the account owner and a child is the beneficiary. This allows the parent to retain control over the account, preventing the child from making poor decisions with the money, like buying a new car. When determining financial aid eligibility, it is usually better for a parent to be the owner of the 529 account. While this calculation can get complicated, in general, parents are expected to contribute 5.64% of their eligible assets annually towards their child’s tuition. Retirement assets are not counted. The student is expected to contribute 20% of her assets. This is why it is typically recommended to spend down the child’s assets first, if they have any. Grandparents’ assets don’t count at all. So why would you not have the grandparent set up a 529?

The catch is this: If a distribution is taken from a grandparent owned 529, the distribution amount needs to be reported as income on the student’s financial aid form the following year. This can reduce the student’s financial aid amount by up to 50% of the distribution amount. So if $10K was distributed, the aid amount can be reduced by as much as $5K. If financial aid is not a possibility in your situation, this nuance doesn’t matter. If it is a possibility, hold off on taking distributions from a grandparent owned 529 until the last FASFA form is filed, typically the middle of the student’s junior year.

Another way for grandparents to contribute is to simply gift money (within gifting limits) to the parents to be used for college. It will affect the aid amount since it is the parent’s asset as discussed, but not by much. Here are some more pros and cons to having a grandparent owned 529. Be sure to consult with your financial and tax advisor to understand what is best for your specific situation.