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Advisor Perspective

Advisor Perspective

It’s Never Too Late (or Too Early) to Talk With Your Children About Money

Erik Faust

Few things bring Erik as much satisfaction as guiding clients through thorny issues or easing their concerns about problems that keep them up at night.

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Another school year has come and gone, and summer is finally here. With it, your children will naturally shift their focus from their studies to their summer plans. Will they get summer jobs? Are they headed off to college? Or are they simply focused on having fun with friends and family? For many, the answer to these questions will be a resounding “yes!” But before summer really heats up, now may be a good time to talk with them about money.

Recent surveys have shown most parents (83 percent) agree it’s never too early to begin talking with their children about money, but only about half (56 percent) have followed through.1 While starting the conversation is a step in the right direction, we also need to think about how we talk about it with our young ones. Words and actions can be very effective, so it’s not only important to help your children understand the concept of money, but also show them how you put your beliefs about money into practice.

Most children understand the concept that you work to earn money. They may even have jobs. Perhaps they earned an allowance in the past. But after you earn the money, what then? Do you save it? Yes. How? It depends. Do you spend it? Of course. On what? The list is endless. And what is the opportunity cost of your decisions in monetary terms?

These are all questions we may have thought about at one time or another and you likely have a detailed answer to each question. But these questions may not always be top of mind for the young ones in our lives. A couple of areas I always like to focus on – especially with teenagers – are opportunity cost and saving.

Let’s start with opportunity cost. Opportunity cost is what you give up when you choose between two options. For example, when faced with the decision to work a few hours on Saturday night and make $40 or go out with friends and spend $25, teens (myself included) often opt for the latter because hanging out with friends is fun and working isn’t. At the time, I always just looked at the $25 as my cost of going out with friends. Paying $25 to have fun? Sure, why not? Sign me up.

What I didn’t recognize was what I gave up to hang out with my friends (the other $40). That night out cost me $65 rather than $25. It likely would have taken me seven to eight hours of work to recoup that money. Knowing all that, would I have made the same decision? Maybe, but it would have been much more difficult had I realized the full consequences.

Now, let’s turn our attention to saving. This is a basic concept that most children will understand. But what they might not realize are the various avenues available to them to save. Depending on their ages and roles, they may have an employer 401(k) plan or a Roth 401(k). If not, young people can fund a traditional individual retirement account (IRA) or Roth IRA if they have earned income.

Funding a Roth IRA is typically going to be the best answer for young individuals, as the power of tax-free compounded growth is exponential, and they typically won’t derive any tax benefits from an IRA contribution because of their low incomes.

As an example, let’s say your child earns $5,000 from a summer job. You’ve done a great job educating him on the power of compounded interest, so he agrees to save $1,000 of that income. At that income level, he would have no federal income tax liability, so contributing to a traditional IRA offers no tax benefit. Furthermore, he will eventually have to pay a tax when he withdraws money from the IRA.

In contrast, If he contributes to a Roth IRA, he won’t have to pay tax on that money later. To bring it full circle, in 50 years at a 7 percent rate of return, that $1,000 becomes $29,457. If it’s in a Roth IRA, he will keep all of it. If it’s in a traditional IRA and he’s in the 32 percent tax bracket at the time of withdrawal, he will keep only $20,031; $9,426 goes to the government. As you can see, this can have a major effect.

There are numerous ways to talk with your children about money. It’s always good to start with the basics and move onto more advanced concepts. No matter how you approach talking with your children about money, just having the conversation is a success. When you’re sitting around the campfire or enjoying a summer barbecue, don’t be afraid to strike up that conversation. It just might pay off.

1 Chase Slate 2018 Credit Outlook Survey