Note: This blog first appeared on Moneygeek.com in early July 2023.
Raising our children to make wise money choices is an important part of parenting. We all want our children to be fiscally responsible, and, as adults, be financially independent, free of the burdens of credit card and other unnecessary debt. We also want to help our children develop and maintain good credit so they have more options available to them as they move through life.
As parents, how do we teach financial skills? I believe teaching children about financial responsibility can begin at a young age. Two options to consider are an unconditional allowance and the “three jar budgeting method”
Allowance
Children as young as five can be given an allowance of five to ten dollars a week – one or two dollars for every year they are old. Making the allowance unconditional and not linked to chores gives them a regular payment, similar to a salary, with which they can practice and learn to manage money.
With every birthday, the amount of the allowance increases by one or two dollars until they are 12 years old. At age 12, their allowance is cut in half and children can earn some of their own money by babysitting, tutoring, dog walking, mowing lawns, or other pre-teen jobs.
The Three Jar Method
Using the three jar method with an allowance provides structure to teach children budgeting skills. Give your child three jars labeled “Spend,” “Save,” and “Giving.” Every dollar they receive, whether it is from allowance, gifts, or earnings, is divided between the jars. For example:
- 60 percent of their money can be put into the Spending Jar. This is money they can spend as they choose. It can be used for trinkets, treats, and other small purchases. Allow your child to decide how and when they want to spend this money. Having control over their spending money gives them the opportunity to make mistakes now when the stakes are low. And, since they have their own money, they do not need to ask you for some when they want to go to the movies with friends.
- 30 percent can go into the Savings Jar. This money is set aside for a purchase your child wants to make in the future. Have your child set a specific goal. At age five it may be a special toy. For a teenager, it may be a contribution to a car or a school trip. The Savings Jar is a valuable tool to teach children how to set and work toward goals.
- 10 percent can go into the Giving Jar. This is money that is set aside to give to charities. Let your child decide what causes they want to support. This teaches the importance of helping others and giving back to their community.
In addition to budgeting skills, the three jar method teaches children financial responsibility. If they run out of money in one jar, they are not allowed to pull money out of another. Instead, they need to modify their behavior, adjust their budget, or both.
Use Cash
When children are young, I recommend giving them their weekly allowance in cash that can be easily divided and placed into their jars. This allows them to touch and feel the money. When they spend it, they can see it leaving their hands and watch the jar empty out.
Transitioning to Bank Accounts
As your children approach their teen years, the jars can be replaced with bank accounts, one for each jar. At this point, your child should have budgeting and spending concepts down and you can electronically transfer their allowance. The spending account can have a linked debit card. If they overdraw, I would not allow the bank to automatically transfer money from their savings account to cover the shortage. Instead, this is an excellent opportunity for your child to adjust their behavior, experience the impact of any bank fees, and learn from their mistakes.
The savings and charity accounts provide your child with the opportunity to watch the power of compound interest and how it helps their money grow. Look for a high-interest-bearing savings account. Many online banks offer these.
An alternative to a bank account with a debit card for daily spending money is a prepaid debit card. You can upload the spending portion of their allowance to the card.
Introducing Credit
As your child approaches adulthood, they need to learn how to manage credit and begin building a credit history. Your child’s ability to manage their bank accounts and debit cards can determine when you want to introduce credit. For many kids, the transition year from high school to college or the full-time workforce is a good time.
A good choice for a starter credit card is a “secured credit card”. With this type of card, your child makes a deposit with the issuing bank and their credit limit is equal to the amount of the deposit. If your bank doesn’t offer a secured credit card, ratings of such cards can be found online.
Your child is responsible for paying the credit card bill each month. This is an opportunity to learn that using a credit card is borrowing someone else’s money that needs to be paid back.
Important Rules
With a credit card, I recommend these three credit-building and good money management rules:
- Pay the bill on time. Always. No exceptions.
- Keep the credit utilization ratio below 30 percent of the available credit. If your child needs more credit, they can transfer funds from their savings account to increase the initial deposit.
- Charge only what you can pay in full every month. If your child does carry a balance, have them identify how much interest they are paying and pay off the balance as soon as possible.
Why would you choose a secured credit card over a pre-paid debit card? To help your child build their credit history. Pre-paid debit card usage is not reported to the credit reporting agencies, and thus will not help establish or maintain credit.
Another way to help your child develop their credit history is to add them as an authorized user to one of your credit cards. The card would be reported to your child’s credit file, in addition to yours, and would be included in their credit score. It also allows them to make purchases larger than the credit limit on their own card. An example might be paying for a car repair when they are away from home.
A disadvantage of adding your child as an authorized user to your credit card is they do not have the responsibility to pay the monthly bill. Thus, I would do this in addition to a secured credit card in your child’s name, not in place of it.
If you choose the authorized user option, use a credit card with a relatively low credit limit. Make it a rule that you must pre-approve every purchase. Depending on the item, you may require your child to repay you. For example, if your child is buying tickets to come home from college, you may want to cover this expense. If they are buying tickets to a concert, you may want your child to reimburse you.
Credit Scores
Teaching your child to use credit cards responsibly helps them understand that these cards are financial tools. Credit cards allow them to make purchases easily without having to carry around cash. At the same time, credit cards are loans that need to be paid back regularly and on time. The costs of not doing so can be extremely high, not only to your child’s pocketbook but also to their borrowing reputation.
In our society, having a good credit score is important. Credit scores are necessary to obtain auto insurance, car and other loans, and cell phones. Some employers and landlords check applicants’ credit. Eventually, your child may apply for a mortgage. All these use credit scores to evaluate whether the person is responsible and reliable.
A good time to help our children establish a good credit history and learn financial concepts is when they are young and the cost of making mistakes is relatively low. You can start as soon as your child can count to three. Teaching our children financial responsibility is a process. As young children, they can learn how to budget and manage cash. When they are pre-teens, they can transition those skills to managing bank accounts and debit cards. Finally, as they transition from high school, they can learn to use credit cards responsibly.
Each of these steps builds on one another to help our children get established in life with a savings fund, a credit score, and solid money skills. Hopefully From Three Jars to Credit Cards: Teaching Children About Money will help you help your children moving forward!
This blog is published to provide you with general information only, and is not intended to provide specific or comprehensive advice. Money Care, LLC encourages individuals to seek advice from competent professionals when appropriate.
