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Advice On Your Child's Allowance

Allowances are a great hands-on way to teach kids to budget, spend wisely and save. Children who learn those skills will be better equipped to deal with financial situations in adulthood. The ultimate goal, says Saturday Early Show Personal Finance Contributor Ray Martin, is self-reliance.

Of course, not all parents and families provide an allowance. The decision to do so depends on personal and economic circumstances. There seems to be a wide variety of thoughts and techniques on this issue. Here are a few tips if you do provide an allowance or money to your kids:

  • Use an allowance as a tool. It is a tool to learn smart money management, not a petty cash fund they can throw away.
  • Create a spending budget.
  • Don't come to the rescue. If the allowance was slated to last for two weeks and they run out, don't buckle. Or if they blow the whole amount on trading cards, and they want a new shirt for school, don't give them the money.
  • Be consistent: Same time and Same amount. Paying a set amount on a regular basis sets the stage for money management habits that are more useful in the "real world." The child might more quickly learn that their spending has limits and that budgeting is important, because there is no more money until the next "paycheck."
What are the alternatives to paying them money directly?
  • Consider a brokerage account. Parents who own shares of highly appreciated stocks or mutual funds should consider opening a brokerage account for the child and paying their allowance in the form of a few shares of stock. That's because children over 14 pay tax on the gains over the parents' cost at their rates, which can be much lower than the parents'. The result: the family keeps more and the IRS gets less.
  • Consider employing your child. Parents who own their own business are advised to employ and pay their children a modest salary instead of giving them an allowance. This is for good reason: the child can claim up to $4,300 tax free. Any amount above that is taxed at their lower rate, and they'll have earnings to report, which allows them to contribute to an IRA. There are rules for doing this. (See Publication 334 - Tax Guide for Small Businesses and Publication 590 - Individual Retirement Arrangements.)

    Of course, the IRS frowns on tax avoidance scams. Paying a child a sizeable salary while they are away at college is definitely on the IRS' list of no-nos.

According to a survey by Ohio State University, about half of the 9,000 teen-agers polled reported getting an allowance. (And that means about half of them did not report getting an allowance.)

Among those teens that do get an allowance, $50 a week is the median amount. But how much allowance children rceive is highly affected by their families' economic position. Children from families with incomes of $20,000 or less get $12 to $14 a week and those from families with incomes from $30,000 to $40,000 get $21 a week. Children from families with incomes over $100,000 receive an eye-popping $175 a week.

A quarter of those who do get an allowance receive $7 or less a week. Family size also matters; where there are five or more kids, the median weekly amount drops to $23. Parents often pay an only child more (one of the perks of being an only child).

Money given to kids is neither taxable to them nor reportable by the parent when the total is less than $10,000 per year (about $192 a week). When the total of all gifts and allowances is greater than $10,000, the amount must be reported to the IRS on Form 709, or 709A (see Publication 950 - Introduction to Estate and Gift Taxes). It's possible a gift tax may be assessed on the donor.

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