One of the questions I’m often asked is how to teach kids to handle credit cards and other kinds of plastic. And I’ve always recommended a four-step sequence. First, children should learn to manage cold, hard cash in the form of an allowance. Then they can move on to making deposits into and withdrawals from a bank account using a basic ATM card. Next comes a debit card attached to a checking account, which lets them make purchases and teaches them how to balance their account. Finally, they can apply for a credit card on their own when they have the experience and maturity to handle it.
But there’s been an upheaval in the financial-services industry over the past few years: credit card legislation, new rules (and fees) for debit cards, a flurry of celebrity-endorsed prepaid cards, and the advent of digital wallets, which let you pay with a swipe of your smart phone and require no plastic at all. So I thought this would be a good time to take stock of my advice and see if it’s still valid.
After reevaluating my strategy, I’m sticking to it -- with a few updates. I repeat my mantra: When dealing with children and their finances, we adults have to think like kids. Changes in the financial-services industry are generally aimed at adults, who value cost and convenience. But it’s important for kids to learn hands-on lessons that build on one another.
Cash is the cornerstone. The idea of a digital wallet may offer the ultimate in convenience, but it also presents dangers for kids (and adults) because it makes it too easy to spend money. Studies consistently show that it’s more painful -- literally and figuratively -- to part with actual money than to pay with a money substitute such as a credit card. Kids need to feel the pain and learn this discipline before they move on to more sophisticated payment systems.
Use a debit card wisely. Despite the flap about fees and overdraft charges, I think debit cards are still the best way to teach older teens and college students how to manage a stash of real money without overdrawing their account. As one father put it, using a checking account with a debit card “added a little more discipline” to his daughter’s budgeting and spending than using a credit card.
What’s changed recently is that kids and parents have to be vigilant to get the best deals and avoid charges. For example, credit unions are good sources for free checking accounts (find a credit union at www.culookup.com or www.asmarterchoice.org), and so are community banks.
Your kids can avoid the dreaded $35 overdraft fee by not giving a bank permission to enroll them in its overdraft protection plan. That means ATM withdrawals and debit transactions could be declined (except for checks) and cause them some embarrassment, but their accounts will stay in the black. Another option: Link a checking account to a savings account from which the bank will transfer funds if necessary (for a fee of about $10).
Stay away from prepaid cards. No matter how many celebrities hype these cards, I just can’t warm to them. For one thing, they come with lots of monthly fees and usage charges. For another, I think kids are better off establishing a relationship with a financial institution. In addition to a checking account, they could potentially have a savings account, a credit card -- and when they’re older, obtain a car loan or a mortgage.
Rather than a long-term money-management tool, prepaid cards seem to be most useful in specific situations -- for example, if a youngster is going out of town on a class trip, or if a college student chronically overdraws his or her checking account (which is less likely if you follow the plan outlined in this column).
Save a credit card for last. Young people under 21 must have an adult co-signer to get a credit card, or you may name your child as an authorized user of your card. For some families, these arrangements seem to work out just fine, but I have reservations about both of them. In each case, mixing credit records could put your credit rating on the line if your kid screws up (see Why You Shouldn't Cosign Your Child's Credit Card).
And remember: As long as you’re paying the bills, kids won’t take full responsibility. Even if things work out well, there’s no guarantee they’ll be able to qualify for credit at the best rates -- as one young man discovered when he was turned down for a prime card despite his clean record and history as an authorized user on his parents’ credit card. Young people simply haven’t had time to build a robust credit history. To beef up their profile, they can apply for a card on their own through their bank or credit union (assuming they have a relationship), or for a retail card, which is often easier to get. Or they can apply for a secured credit card (see Getting Your First Credit Card).
If your kids follow this blueprint, they’ll know how to control their spending, pay bills on time, balance their checking account and avoid fees. And they’ll even have the financial acumen to tackle the virtual world of digital wallets.
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Janet Bodnar is editor-at-large of Kiplinger's Personal Finance, a position she assumed after retiring as editor of the magazine after eight years at the helm. She is a nationally recognized expert on the subjects of women and money, children's and family finances, and financial literacy. She is the author of two books, Money Smart Women and Raising Money Smart Kids. As editor-at-large, she writes two popular columns for Kiplinger, "Money Smart Women" and "Living in Retirement." Bodnar is a graduate of St. Bonaventure University and is a member of its Board of Trustees. She received her master's degree from Columbia University, where she was also a Knight-Bagehot Fellow in Business and Economics Journalism.