Personal Financial Management Should be Learned From a Young Age
Why Teaching Financial Responsibility to Children and Teens Can Pay Dividends in Adulthood
In the United States, many children and young adults move throughout the traditional school system without any introduction to the world of personal finance. Instead, they learn about money management from various sources, including a parent or trusted adult, friends, television or the internet.
Some children and teens learn about finances from their own experiences, which can be a lot like learning something “the hard way”. But the learning experience doesn’t have to be that way.
A new school year is just around the corner, and while it’s never too early to begin teaching your children the value of money and how it can advance their lives, these lessons become especially important as they reach certain milestones, such as their first job, wanting a car or graduating high school.
These milestone occasions serve as great teaching moments to help your children become financially independent adults.
High School is a Perfect Time to Begin Financial Management Education
High school brings many new experiences and responsibilities that help kids prepare for the real world. Outside of history class, sports practices, starring in the school’s production of Rent, and making new memories with friends, these young adults are also getting their driver’s licenses, potentially working at a part-time job, and applying for college or trade school. Don’t miss the opportunity to introduce important personal finance concepts related to these events.
Teaching children the importance of personal finance and empowering them to make rational and thoughtful decisions can seem overwhelming – and many parents avoid it altogether for that reason – but by breaking it down into smaller pieces, you can give your child a solid foundation on which to build their financial lives, and better prepare them for success.
Teach Financial Lessons Related to a Part-Time Job
While a child in grade school may take on some odd jobs around the house or for neighbors to earn a little spending money, young adults are more likely to engage in part-time work with an established employer to support their spending needs. With this step comes the opportunity to begin making a plan for the money your child is working hard to earn. Organization is key, but with today’s advancements in technology, getting and staying organized can be an automated and seamless process.
Here are some key ways to get your teenager involved in responsible financial management:
Open a Personal Checking or Savings Account
To open a checking or savings account in the United States, the account holder must be 18 years of age or older, unless the account can be opened jointly with a parent or trusted adult. Having a checking account is a great way to help a child to track their spending, because transactions are recorded and saved electronically, generating a statement at month end showing all transactions that occurred in the account.
It can be much more challenging to track spending without a checking account, as your child will need to actively monitor cash on hand, and purchases will need to be recorded manually. Other benefits of a checking account include:
- Reduces risk by keeping assets safe at the bank, compared to carrying cash on hand.
- Accessible online for better security and awareness and management of funds.
- Option for paperless statements for account activity tracking, record keeping, and to avoid the information from falling into the wrong hands.
- Account alerts to notify them immediately when certain types of transactions occur in the account, allowing for a proactive response if their information is compromised.
Utilize Online Money Management Tools
Once the checking and savings accounts are open, linking them to a money management website like Mint.com can help your child to get and stay organized. Whether a checking or savings account (or both), a credit card or a loan, transactions are uploaded and categorized in real time. By using the site’s budgeting tool, dollar amounts can be allocated to certain categories, and progress is tracked as expenses in those categories are uploaded into the system.
These types of tools also offer a mobile app that allows your child to review their progress regularly, and even check in on budgets while they’re on the go to help them decide whether they can truly buy that new pair of shoes or video game!
By tracking spending, your child can continue to refine their budget and set realistic expectations, and also make changes to their spending patterns to achieve different goals.
Encourage a Focus on Regular Expenses and “Fixed” Costs
A common financial lesson introduced to younger children is the save-spend-donate rule, where the child is encouraged to divide any money they receive between these three categories. Children tend not to have regular expenses, so this general concept around budgeting and charitable giving is sufficient.
However, a high school student begins to have regular expenses such as fuel (and sometimes auto insurance), food and/or entertainment with friends, or their own cell phone bill. A more detailed budget can help them ensure their expenses are covered and can also show them how much they can save for future needs, which should become an “expense” like any other.
There are two ways to approach budgeting –top down or bottom up:
- A “top down” budget is built by subtracting expenses in order of importance from the amount available to spend on a monthly basis.
- A “bottom up” budget is built by listing out all expenses with estimates of cost on a monthly basis.
Your child should also begin to think about how much they’d like to set aside for their savings goals, or unplanned expenses, and include those savings as part of their budget – also known as “paying yourself first.”
After the Financial Management Lessons, What’s Next?
Investing Early for Future Retirement. If your high school student has earned income from a part-time job, they are eligible to contribute to an individual retirement account (IRA), limited to $6,000 or their annual earnings, whichever is less (per 2019 regulations). For those earning less than $122,000 (and filing their tax return as single or head of a household), the Roth IRA is the retirement investment vehicle of choice, especially if tax rates are expected to rise in the future – as young adults can expect as they progress in their careers and increase their earnings over time. Contributions are made on a post-tax basis, and can be withdrawn at any time without taxes or penalties. (Note that investment earnings may be subject to tax and penalties.) Whether your child begins saving for retirement or for another goal, adding a line item to their budget will allow them to “pay themselves first” when allocating their income.
Budgeting for Auto Insurance. If your child has their driver’s license and access to a vehicle, they must be covered under an auto insurance policy. Due to the high premiums applied to policies with younger drivers, young adults may not yet be paying for their own coverage; however, it is still a great opportunity to teach them about the mechanics of an auto insurance policy, like the difference between comprehensive and collision coverage, the importance of liability and uninsured/underinsured motorist coverage, and the implications of speeding violations and accidents on the policy premium and the driver’s insurability.
Preparing for the Cost of Post-Secondary Education. As your child begins to enter their final year of high school, the college or trade school application process is likely underway. While there are a number of young adults fortunate enough to fully fund their educations, or achieve scholarships to assist with payment, student loans are still an incredibly popular and useful vehicle to fill in any funding gaps. This process is generally a child’s first experience with debt. The loans are applied for and obtained by the child directly, so it’s important to discuss the implications of debt, such as interest, repayment, and how a loan can affect their credit down the road.
Learning Personal Financial Management Lessons for College and Beyond
Once your child turns 18, they are legally considered an adult. And with adulthood comes new privileges and responsibilities that did not exist before, which all feed into financial independence. Owning their bank and brokerage accounts individually, obtaining and building credit, and even creating their own estate plan are all important facets of personal finance that will remain constant throughout their lives. There are several areas in which your child can practice responsible spending and financial management at this point in their lives.
- Building Credit Responsibly. Unless your child has student loans, chances are their credit report doesn’t yet exist or has very little activity once they turn 18. A credit card can help them to begin building credit – but can also hurt their credit if not used properly. Credit card issuers report balance and payment activity to the three credit bureaus on a monthly basis – paying on time and in full each month will help to build a healthy credit score. It’s important to ensure your child understands that using a credit card means they are actually borrowing money from a bank, which must be repaid within a set period to avoid interest and fees. Credit cards can be great for purchases where an additional layer of protection is desirable, whether it’s a built-in card benefit for travel (like rental car coverage or trip interruption reimbursements), general purchase protection (replaces or reimburses the cardholder for broken items or items that are past the allowed return date), or for increased security (like fraud protection). Adding a line item to their budget for their credit card bill is a great way to ensure it is paid in full and on time, and allows for careful planning when tracking their spending each month.
- Maintaining a Strong Credit Score. Credit scores determine the kind of life your child can have – and the freedom they have to choose how they want to live. Not having a good credit score can eliminate a lot of potential options for lifestyle, as well as opportunities for financial – and in some cases, professional – growth, which can take a long time to fix.
- Estate Planning. The topic of estate planning is more commonly thought to affect those in the later stages of their lives, but it’s actually important to begin addressing it when your child turns 18. At this point, a parent or guardian can no longer make healthcare or financial decisions on behalf of their child without court involvement. It’s not uncommon for a child to sign a healthcare proxy or HIPAA (Health Insurance Portability and Accountability Act) release, allowing someone else to make healthcare decisions for them, and receive information about the status of their health should they become sick or injured. If your child hasn’t received a form to sign, it may be worth reaching out to their college to see what they offer in terms of authorization for decision makers. A Durable Power of Attorney for finances allows parents to access their child’s bank accounts or receive information about accounts in the interest of managing bills, closing accounts, or transferring funds. They can also sign legal documents on behalf of their child should they become incapacitated.
- Drafting a Will. While useful during your child’s life, a Durable Power of Attorney expires at one’s death, so it’s also important to draft a will to dictate how assets should be distributed at that time. Working with the family attorney, or finding a new one that specializes in estate planning for younger individuals and families is a great step toward getting your child’s estate plan in place. (It can also offer peace of mind in that you are still in a position to act in the best interest of your child.)
- Off-Campus or Apartment Living. It’s increasingly common for college students to move off campus at some point during their time at school, which involves additional planning and responsibilities as they live independently. Alongside budgeting for rent payments and utilities (and ensuring they’re paid on time), it’s also important for your child to obtain the necessary insurance to protect themselves in the event of a loss. A renter’s insurance policy can typically be obtained from the same insurance carrier or agency that provides their auto insurance coverage, and will protect their personal items should something happen to the apartment – whether it involves fire, water or other damage, or theft. Your child will also want to begin thinking about umbrella coverage as well, which extends increased liability coverage to both the apartment and their vehicle, if they aren’t already covered under a your policy. An umbrella policy is essential in the event someone is injured in the child’s apartment, or in the course of an auto accident caused by your child. The goal is to ensure other assets are not forfeited due to a judgment against your child.
- Employer 401(k) Plans. Once your child is out of college and begins working at a full-time job, it’s likely they will be invited to participate in the employer’s 401(k) plan, if offered. Saving for retirement is one of the most (if not the most) significant savings goals in a person’s lifetime, and the power of compound interest and returns for those who start early is vital in their success. A 401(k) plan is an employer-established retirement account, which allows the employee to make pre-tax contributions directly from their paychecks, and employers will typically offer to match the employee’s contributions up to a certain percentage. Even if your child cannot max out their 401(k) contributions early on (the limit is $19,000 for 2019), they can still get a head start by making contributions that are at least equal to the amount of the employer match (it was once said that the best “get rich quick” scheme in existence is the employer matching on a 401(k) account!) As your child’s income increases over time, their contributions should increase as well. Given a retirement account’s long time horizon, the target investment allocation will be more aggressive in earlier years, tapering off to a conservative allocation as they approach retirement. For short-term savings goals, the opposite approach is prudent. The risk of losing assets needed for a particular expense in the near future is too great to risk not having enough for a goal.
Fostering Financial Responsibility for Life
With so many important changes and developments in a child’s life from grade school forward, teaching responsible management of their personal finances can only result in greater success and better decision-making through their adulthood.
Parents can set an enormous example to their children when it comes to money management, even if just through communication and discussion. Take advantage of opportunities like your child’s first job and car, and of life changes like their post-secondary education and living situation to teach these valuable financial lessons.