Small Incentives Can Have a Big Impact

“Give your kids enough to do anything, but not enough to do nothing.”

With the distractions and commitments kids have these days, it can be hard to find the right time and the best way to teach good money habits. Whether it’s learning simple budgeting skills or the benefits of saving for a long-term goal such as retirement, there is never a better time to start.

Just consider the impact of a kid investing $1,000 at age 12 versus waiting 10 years until after graduating from college. If the funds are to be used in retirement 50 years later and grow at a 8% annual rate, that $1,000 initial investment would grow to $46,901 with 50 years of compounding, versus $21,725 with 40 years to compound. The additional 10-year investment horizon for the 12-year-old leads to a greater than 50% increase in accumulated wealth due to the power of compounding.

Even though the benefits of starting to save and invest early are apparent, it can be difficult for a kid to understand the consequences of waiting to save for a car, house down payment or retirement when these obligations are far in the future. Providing small incentives can often bridge this gap. To teach kids a lifelong lesson, you can create a system of dollar-for-dollar matching of contributions to savings, matching a certain percent or even contributing on their behalf, to incentivize them to participate in school activities like debate club, student government, or choir. As a parent, you will in essence be providing an employer-like match on their contributions.

Savings account

Once your kid understands the basics of budgeting and why they should spend less than they take in, it’s time to open a savings account. You could help your child open the account online, but going to the bank may give them the best learning experience. A personal banker can help them open the account, and they can learn how to deposit and withdraw money, and then record those transactions.

After opening the savings account you can start offering small incentives, whether it’s contributing on your child’s behalf for good grades in school or paying them for chores around the house.

Roth IRA

There’s no minimum age for opening and contributing to a Roth IRA, as long as the minor has earned income from a job that issues a W-2 or 1099-MISC. An allowance for cleaning their room doesn’t count as earned income! For 2016, the most they can contribute to a Roth IRA is either $5,500, or their earned income for the year – whichever is smaller. A parent or guardian needs to be listed on the account until the child is no longer a minor.

If your kid has any amount of earned income during the year, a contribution to a Roth IRA provides tax-free growth and withdrawal in retirement. If your kid earns $600, you can match anything they contribute dollar for dollar, which can help incentivize them to contribute, say, half their earnings. So if they contribute $300, they receive $300 free money from you. The $300 they have left over can then be used on whatever they want!

Roth IRAs for minors can be opened at discount brokerages like Charles Schwab, TD Ameritrade, Vanguard or Fidelity.

Brokerage account

If your kid doesn’t have earned income to contribute to a Roth IRA, investing through a taxable brokerage account can provide many of the same benefits. Similar to a minor Roth IRA, a brokerage account needs to have a custodian, such as a parent, listed on the account until they are 18 or older, depending on the state the account is opened in.

This type of account provides more flexibility for withdrawals than a retirement account, and there’s no limit on the amount that can be deposited. These funds can be invested toward goals like saving for a car in the future, a house down payment or even to supplement retirement savings. A similar incentive system would work in this case.

In most cases, you can open this type of custodial account online at discount brokerages like Charles Schwab, TD Ameritrade, Vanguard or Fidelity.

Encouraging good savings habits and educating children on the power of compound interest will result in significant long-term benefits, both personally and financially. More importantly, it will help reduce their chance of encountering a shortfall in savings when it comes to their most important goals as they grow up.