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Allowance for Kids: How You Pay Can Teach Important Lessons

Earlier this week I wrote about how paying an allowance to your children can be an important financial teaching tool. This blog post expands on how to pay and setting up a practical system of accounts for allowances.

How to Pay
Parents commonly pay their children's allowance one of three ways: paid as requested or needed, paid regularly as set periodic payments, or a combination of the two. Giving money to kids on request for a day at the mall or to have some spending money on hand can add up. The problem with this is that it's difficult to keep track of and neither the parent nor the child has an idea of the amount of money that has changed hands over the course of a year. This also fosters money habits that in the future can lead to impulse spending problems.

Paying a set amount every week sets the stage for real world money management habits. The child might more quickly learn that their spending has limits (this may sound familiar) and that budgeting is important because there is no more money until the next "pay day."

Also it's important to pay on time at a set schedule and to never miss a payment. One of the lessons that an allowance is supposed to teach is discipline, and that your children will expect to receive their allowance on their "pay day."

Living on Net Pay
One of the lessons an allowance can teach that is particularly valuable for the real-world is to live beneath your means. For example, if you pay an allowance of $10 per week to your child, then work out an arrangement where they will set aside $2 for saving and $1 for giving, and they can use the remaining $7 for spending. This helps to teach the lesson of "gross pay" and "net pay" and saving for future expenses like a car or college. Don't expect these concepts to sink in right away, but if you stick to this approach, you will lay the foundation for the day when they later receive income from work outside the home.

Allowance Accounts
If all of this sounds too tedious -- after all, who has the time to go to the bank each week, get cash and break out an allowance into small amounts for spending, saving, and giving - then consider this solution:

Take your children to your bank and sit down with one of the bank's customer service officers. Explain that you want to open two accounts for each child -- one for spending and one for saving/giving. Have your children bring some of their cash savings with them to use for the initial deposit into their accounts.

Have these accounts linked to your own account so you can then access and view them on one screen when you log into your bank's web site. And request an ATM card for each of your children's accounts.

When you get home, log onto the banking website with your children. Check the accounts and view the initial deposits made. On most sites, you can also assign nicknames to the accounts for each child. Then set up the automatic transfers for the allowance payments to each of the accounts.

I personally use this arrangement and it works really well for our family. We never miss an allowance payment. Our kids, with our supervision, can log onto their accounts and see how much money they have to spend, to give, and how much they have saved. When they need cash, we go to an ATM and they use their card to access their account and make a withdrawal. This arrangement teaches them at an early age how to deal with money electronically and online. After all, that will be the way they deal with money and banking in their lives.

When to Stop
Parents often end allowances when their teen gets their first job. Many teens see getting "cut off" as a downside to getting a job, especially if their allowance paid for daily household chores they are expected to continue doing. Alternatively, spending-based allowances are viewed as a transition to independence that comes when getting a regular paying job, something that helps establish realistic financial expectations.

Also, encourage saving and investing by setting up an investment account and offering to make matching contributions for each dollar contributed up to an annual limit. What you teach your children about managing their money will make a difference in their financial behavior for the rest of their lives.

More on MoneyWatch:
Children's Allowances: What and When to Pay