Tana Gildea

Help Your Kids March Toward Financial Security, Part 2

In a previous post, we talked about the importance of helping our kids March Toward Financial Security by having conversations about saving and how best to allocate a paycheck – or any money that comes their way.

We want to continue that theme by exploring ideas to help them save and invest on their own. An obvious first step is to open accounts like savings and checking accounts. You can walk into your own bank with your teen and open accounts like we did when we were kids. (Anybody remember having a “passbook?” Yes, I am that old.) Some banks allow teens to have their own account in their name prior to age 18; others may require a parent to be a joint account holder. Regardless, I recommend setting up balance alerts or some other method of monitoring because there are likely to be a few “oops” moments as your teen is learning the mechanics of banking, and overdraft fees are not cheap. (Although offer a good teaching moment!)

There are now many online options for teens to open an account from the convenience of a phone. Do your research and check ratings and user comments. Sites like NerdWallet and The Balance have ratings for such accounts and a quick online search will lead you to articles and resources to help analyze the options. The important part is to make sure that you help your child understand how these accounts work and what tools the online app has for monitoring and tracking.

The more interesting part comes in working through the mechanics of depositing paychecks and setting up automatic transfers to savings and investment accounts. What a gift it is to teens to get them primed to have a formula for receiving money:

  • X% to charity (if that’s important to your family),
  • Y% to the emergency savings account, and
  • Z% to long-term investing.
  • Maybe you add a C% for saving for college or a G% for paying for gas each week.

Teaching teens how to allocate their earnings to important goals and priorities sets them up for financial success throughout their lives. They don’t need a job to be introduced to this structure. It is great to set priorities for any money they receive.

This is also an opportunity to teach them about the differences between interest on a savings account and opportunities for dividends and investment growth in an investment account. Savings accounts have low interest rates because the safety of the principal is guaranteed – lower risk, lower reward (interest). Investing carries a risk of loss so must provide greater reward (higher interest rate, dividends, or the opportunity for increases in the value of the investment).

When your teen does have earned income[1] (wages from a job), we recommend they open a Roth IRA account. The beauty of a Roth IRA is that the owner can invest those funds and as long as they follow the Roth rules, they will never be taxed on the returns from those investments (called “unearned” income in tax lingo). Wow – that is a great deal! Interest, dividends, and capital gains over their lifetime build up and are never taxed (under the current tax rules anyway). Unearned income in a non-retirement investment account is subject to tax at “ordinary income” rates which go from 10% to 37%.

It is important to note that the contribution amount is limited to the lessor of earned income or the limit set in the Tax Code which is $6,000 for 2021 and 2022. Other important points:

  • The contribution can be made from any source so a parent could incent savings by matching the teen’s contribution. So, if the teen is going to contribute 20% of their income to the Roth, a parent could match that and gift the teen the money to contribute an additional 20%, thus, doubling the contribution to 40% of income. The limit would be that total contributions cannot exceed the $6,000 limit (2021 & 2022).
  • Everyone has until April 15th to make the contribution for the PRIOR tax year so you can fund 2021’s contribution until April 15, 2022. (They must have earned income for 2021, though, so if they just got a job this year, they would be funding their 2022 contribution.)
  • Your teen should report the contribution on his or her tax return for the year of contribution but is not required to. If no return was required to be filed or they have already filed for 2021, they can still make the contribution. They should track their contributions, and the custodian of the account will send a Form 5498 each year, usually in May, which they should keep for record-keeping purposes.

How should they invest those funds? That is a topic for a different day, but this is a great way to get teens interested in and exploring the differences between stocks, bonds, ETF’s, and mutual funds. All of the online investing platforms like Schwab, TD Ameritrade, and Fidelity have tools and resources to help people learn about investing and are reputable sources of information. Time is a real friend in terms of investing so starting early and investing consistently will make their march toward financial security that much easier.

As part of our Financial Foundations series, we have a free webinar on April 6th at noon on Investing Basics for our clients.  These webinars are a great resource for children of our clients to learn more about the basics of personal finance.

[1] Earned income is a tax-related term and indicates that wages and other such income is available for contributions to retirement accounts like IRAs and Roth IRAs while unearned income, like interest and dividends, is not available for such contributions.

Tana Gildea

Help Your Kids March Toward Financial Security, Part 1

As parents, we all want to raise kids to be independent and competent adults. We work hard to build their self-esteem, their confidence, and guide them through life’s many choices. However, we don’t always do a lot to build their financial skills. Sometimes this is because it’s difficult or uncomfortable to talk about money. Sometimes it’s because we don’t feel very confident in our own financial prowess and are concerned about questions that we may not know how to answer ourselves!

Regardless of the reasons, if we want our kids to be financially stable and secure, it’s up to us to start teaching them about money basics. One easy way to do that is to teach them about saving once they get their first job.

Before the paycheck comes, discuss these questions with your kids:

  • Does your family believe in tithing or making charitable contributions with those first dollars?
  • What percentage of income goes to “emergency” savings? (We recommend at least 10% for those with bills to pay but perhaps much higher for a teen.)
  • What percentage of income goes to long-term financial security? (We recommend at least 10% for those with bills to pay but perhaps much higher for a teen.)
  • Do you expect your child to contribute toward college expenses? What percentage should be saved for that expense?
  • How about for buying or maintaining a car? Do they have responsibilities toward that or for gas and insurance? It’s important to learn that those things get expensive!
  • Do they need to start paying for their cell phone or clothing?
  • How much should be free to spend on “wants,” fun, and entertainment?

If teens get a check and are free to spend it all on anything they want, they go down a spending path. Their wants can get bigger and bigger, and they can become less and less discerning about how they spend their money. When it is time to pay their own bills, it’s a brutal shift in their reality! Most of the money goes to taxes and living expenses! Where’s the fun stuff? (We know, parents feel the pain every payday.)

However, if they learn that earned income should be allocated to financial security first, to basic needs next, and then to “fun stuff,” they learn how life really works for adults. They are building up their own resources and starting to create financial security for themselves separate from their parents. We all hope this creates a feeling of pride and independence for them and puts them on a path to self-sufficiency and financial confidence.

We recommend that parents have these discussions with their teens, whether or not they currently have a job, and share their own beliefs and practices around saving. It’s ok to admit to not knowing all the answers but offering to work together to find good answers. It’s also important to admit to your own financial mistakes and regrets. No one has been perfect with their money, and there is always much to be learned from mistakes. It’s great to teach our kids the power of learning from successes and failures. Henry Ford said it best, “The only real mistake is the one from which we learn nothing.” You bet.

In future posts, we’ll continue to help our kids March Toward Financial Security by discussing the benefits of opening and funding checking and savings accounts, starting Roth IRA accounts, and using other tools to help them improve their financial skills.