When I was a kid, I always enjoyed earning a few dollars doing chores and mowing lawns. My sister and I would work hard to earn $5 picking up pine needles for our dad but had very different ideas on how to spend it. I got a kick out of watching my savings grow in my see-through piggy bank to buy a new video game that I worked hard for. I found that the game I worked hard for gave me a sense of joy that I didn’t get from a game that I asked my parents for just because one of my friends had it. My sister, on the other hand, did not own a piggy bank and she really didn’t need one. Her 5-dollar bill was spent as soon as she earned it. There’s more than one right way to handle money, but it’s important to teach your kids the value of money to set them up for success.
What is financial literacy?
According to Investopedia, “Financial literacy is the ability to understand and effectively use various financial skills, including personal financial management, budgeting, and investing.” In general, financial literacy has to do with all the financial skills that people use to reach life goals such as paying for school, owning a business, and retirement. In the past, Americans paid cash for everything from daily expenses to buying a home. Due to many factors including rising costs and stagnant wages, the middle class relies heavily on debt such as credit cards, student loans and home mortgages. According to a recent study by Standard & Poor’s Global Financial Literacy Survey, 43% of US adults are financially illiterate. Financial literacy begins at home, so set your kids up for success by teaching them about good financial habits.
When should I teach my kids about money?
Young children don’t have to make any financial decisions for themselves, but it’s important to start giving money lessons from an early age. Dave Ramsey breaks down different lessons that can apply to children of different ages. For example, a kindergartner should be given the opportunity to earn coins and dollar bills that they can save in a clear piggy bank. They will be able to see their money grow and take their savings to buy a toy or spend it on something they really want. For children in grades 1 through 8, teach them to earn money by doing chores around the house. While not every kid will want to save up their hard-earned cash, you should teach them to make wise choices on how they spend it. Dave suggests teaching kids to avoid impulse buying by having them wait at least a day before purchasing anything over $15. Teenagers should be encouraged to start working, and you should help them find their first job. Once they start working, make them a bank account and teach them about taxes, debt, budgeting, and investing.
Teach your kid about taxes
When your kid starts working, they will need to understand their paycheck. I know from experience that $10 an hour sounded like so much money until I saw my first paycheck. Nobody likes paying taxes, but you should teach your kids why taxes are being pulled out of each paycheck. Federal income tax is taken out based on the way they fill out their W-4 form. Unless they earn more than $12,000 in the year, any federal income tax withheld for the year can be claimed on that year’s tax return. FICA taxes, also known as payroll taxes, are taken out to contribute to Social Security and Medicare. They should understand that this 7.6% deduction from each paycheck is matched by their employer and cannot be refunded by filing taxes. This money isn’t held in a personal bank account when they retire, but it does lead to a benefit for them at retirement. For more tax education, check out my blog on tax planning https://molentax.com/how-to-start-tax-planning/ and bring your whole family to your next tax appointment!
How do you explain debt to a child?
It’s important to be a good example of how to handle debt by showing your child your financial situation and practicing what you preach. Showing positive ways that you have used debt such as a home mortgage, student loans, or a car note can provide real world examples of how responsibly debt should be handled. You should teach your kids about how these lines of credit can build or destroy their credit score, and all the benefits of a high score. For a detailed explanation of how credit scores work check out my blog https://molentax.com/what-is-credit-and-how-do-i-get-it/. Under close supervision, add your kids to one of your credit card accounts so they can begin to build their own credit score. You should stress the common credit card trap that people fall into when they max out their cards, are charged significant interest, and destroy their credit.
Create a budget with your kid
While everyone’s financial goals are different, understanding how to make a budget that works for you is a great way to reach those goals. As soon as they start earning money from doing chores or working their first job, you should motivate your kid to save some of their money. Working with them to create a budget can be as simple as separating money into what can be spent now, and what is going to be saved for later. In order to continue your child’s education on budgeting, make sure you understand how to budget your own finances with some of our budgeting tips https://molentax.com/do-i-need-a-budget/. As mentioned in this blog, budgeting can be done in a way that best suits your needs. There are many helpful apps that can do most of the work for you, so don’t assume that budgeting is too time consuming.
Teaching your kid about investing
Significant inflation in our country causes our money losing value every year unless it earns more than the current inflation rate. Understanding compound interest and how tax advantaged retirement accounts grow your wealth are important. Once your kid understands the basics of earning money and saving, you should explain how the money they save can grow over time. The challenge is that most kids only understand the immediate satisfaction of spending money, so it is important to help them understand the rewards of investing. Instead of focusing on not being able to use their money for a long time, teach them to pay themselves first. If they budget $10 of every paycheck in an investment account, they can watch their wealth grow.
Tax Advisor, EA