The Best Way to Dole Out Kids' Allowances

Giving children money each week to help them learn to budget isn’t as straightforward as it sounds.

Kid counting pennies
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For decades, parents have dutifully paid allowances to their children, often in exchange for chores around the house. Most of the time, they probably think they're passing on the value of hard work and teaching important lessons on how to save and spend. It turns out they're mistaken.

According to new findings, paying children an allowance can do more harm than good when it comes to their future financial literacy skills. According to Lewis Mandell, a professor of finance at the University of Washington who recently studied more than 50 years' worth of allowance research, "The kids who receive [a regular, unconditional] allowance tend to think far less about money in general." In fact, he adds, those children appear more likely to grow up to be "slackers," since they aren't learning to associate work with money.

Paying children for chores around the house can also lead to problems because it teaches them that working for money isn't fun, warns Alisa T. Weinstein, author of Earn It, Learn It: Teach Your Child the Value of Money, Work, and Time Well Spent. Paying for good grades creates a similar problem: Instead of being driven by self-motivation, children learn to work hard just to earn the extra cash.

[Read: 6 Fun Ways to Teach Kids About Money.]

Many parents, who are already stretched for time, skip regular allowances altogether, which isn't necessarily a bad thing. According to Mandell's review of decades of research, children who have to ask their parents for money each time they need it, whether it's for clothes or lunch, tend to fare better with money later in life. Perhaps that's because they are forced to think about what money is being used for, he says. "The kids who have to ask for the money have higher financial literacy than those who get allowances," says Mandell.

But is there a smarter way to pay children an allowance, so that they learn how to handle money at an early age? Mandell says parents should talk about family finances with their children when they pay an allowance. "Allowance can be used very constructively, but to use it constructively requires time, effort, and a degree of honesty on the part of the parent," he explains. "Most parents don't want to do it because they don't have much time," he adds.

Another alternative, and the subject of Weinstein's book, is to connect the allowance with tasks related to various careers. Children can choose a career—50 are profiled in the book, including a geologist, travel agent, and chef—and then complete tasks related to that career. Travel-agent tasks include reporting on a destination in an appealing way, creating a brochure, and for older children, calculating exchange rates.

"This way, the child is making the connection between effort and money, and the feeling that you worked hard for something. If you can capture that, then you're much more likely to have a child who grows up and can find emotional and financial fulfillment in their careers," says Weinstein.

[Read: How Parents Should, and Shouldn't, Talk to Their Kids About Family Finances.]

Dan Henderson, founder of the financial education toy line Zillionz, says consistency is one of the most important aspects of an allowance. Sticking with a regular schedule, whether it's weekly or monthly, lets children plan for and anticipate their "income," and also sends the message that it's important to uphold financial commitments.

Henderson also recommends helping children learn what to do with their allowance by teaching them to dedicate a portion (30 percent) to spending, 30 percent to short-term savings for bigger purchases such as a bike, 30 percent to long-term savings such as college, and 10 percent to giving.

That's a similar concept to the one promoted by Money Savvy Generation, a company co-founded by former financial-services professional Susan Beacham. She invented a piggy bank with four compartments—save, spend, donate, and invest—to teach kids how to budget. "You're teaching them to stop, pause, and reflect, and this is the first step toward teaching them to delay gratification," she says.