Using an allowance to teach kids about money may seem a little strange for some parents. Regularly handing over money for nothing? It seems a little counter-productive, not to mention that it might send the wrong message about where most of our money comes from. But paying children to do household chores that they should be doing anyway also seems not quite right to many parents.

An allowance can be a vital part of teaching children how to handle money and to make wise decisions. However, the challenge is providing this allowance in such a way as to make sure kids earn it in some way. But earning an allowance doesn’t always mean getting directly paid for some chore or service. Instead, kids can show they deserve their allowance by following guidelines you set for them.

Set Allowance Rules

Explain to your children that you expect them to learn to make good money decisions. Let them know that they can show you that they deserve an allowance by making good choices, including saving money for short-term and long-term goals, donating money to charity and even investing it.

It is also important to set rules about what children will be required to buy with their allowance. How much will they have to contribute toward sports teams and other extra-curricular activities? Will they have to buy some of their own school clothes? If they don’t make a lunch and bring it school, will they have to buy their own food? These are all concerns that need to be worked out. Make sure that allowances are large enough to cover required expenses, plus a little bit that they can use for something extra.

Some parents even have a contract signed with their children, specifying how much their kids receive each month, and what they are expected to cover using money from an allowance. Susan Beacham, founder of Money Savvy Generation, uses this technique. She explains on that an allowance with strings attached teaches financial responsibility and prepares children for what we lovingly refer to as the “real world."

“I’m trying to teach them the habit of choice,” Beacham said. “First of all, their allowance is for expense coverage. It’s not money just for breathing ... and I’ve told them, ‘Now you have to do what I do when I get paid. You have to put some money away, donate some money and invest some money for the future. You have to pay yourself first.’”

As your children grow up and get their own part-time, after-school jobs, you can cut back on the allowance, and adjust how expenses are paid out. Make it clear that, even though some of their allowance money can be used for fun things, the main purpose is to teach your kids how to budget and spend their money wisely so that they can be financially responsible adults.

Allowance and chores

Many financial and parenting experts warn against paying children for regular household chores. MSN Money points this out about the value of having jobs for children to do—without monetary compensation—around the house.

"My recommendation is to keep the allowance totally separate from the chores," says Aletha Solter, a developmental psychologist and founder of the Aware Parenting Institute in Goleta, Calif. "That way, children will learn the value of cooperation and experience what it feels like to contribute to the family."

That doesn’t mean, though, that you can’t pay your kids when they go above and beyond. You can offer to pay your children to do harder jobs, like washing windows or cleaning out the garage. This gives them the chance to earn a little extra money on top of their allowance, teaching them the value of doing extra work when they have a specific goal in mind. If you want, you can even encourage them to set some of these extra earnings aside for long-term saving or investing.

Financial literacy is best learned by doing. An allowance can help children develop money management skills from a young age. Setting limits and making it clear that an allowance comes with responsibility teaches kids that they have to earn their way to financial freedom.

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