In this episode of Motley Fool Answers, we'll unpack how banking and managing your money can be much more expensive to do when you're poor. Motley Fool personal finance expert Robert Brokamp interviews Roger Young of T. Rowe Price Group about determining whether you're saving enough for retirement and we answer a question from a generous sister.
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This video was recorded on September 7, 2021.
Alison Southwick: This is Motley Fool Answers. I'm Alison Southwick, joined as always by Robert, I didn't have time to brainstorm a different name for you, Brokamp, Personal Finance Expert here at The Motley Fool. Sorry, Bro, I let you down.
Robert Brokamp: No. That's all right. Perfectly happy with my regular name, so I'm fine with it. Thank you very much.
Southwick: Are you? Really? This week, we talked about how it's expensive to be poor. Bro talks to Roger Young of T. Rowe Price about their guidelines for determining whether you're saving enough for retirement. We'll answer your question from a listener who wants to help her sister save for retirement, best sister ever. All that and more on this week's episode of Motley Fool Answers.
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They say it takes money to make money, it's true. It's also true that it costs money when you don't have money, or a better way to put it, it's expensive to be poor. This is true of a lot of things. Food is more expensive when you don't have a local grocery store or can't afford to buy in bulk. Who wants to carry a 10-gallon jug of pickles on the subway? Not me. Housing is more expensive when you have to stay in a motel because you can't afford a security deposit to rent an apartment. Many other random little things add up, like how it costs more over time to do your laundry at a laundromat when you can afford a washer and dryer? But today, we're just going to focus on banking and how it is more expensive to manage your money when you don't have a lot of it. While cashing your paycheck and paying your bills is pretty tedious for most of us, it's actually a challenge for those who are poor or lack stable income. A few years back, many big banks realized they weren't making enough money off of small accounts. Instead of offering free, no minimum balance checking accounts, the kind popular with many low income customers, they decided to require minimum balances. If customers fall below that threshold, they have to pay a monthly fee. That's right. If you don't have enough money in your checking account, you have to pay the bank $10-15 that you probably don't have because if you did, you'd have it in your checking account. After you pay any fees for not having a minimum balance, let's say you overdraft your checking account, you'll get hit with a $35 fee every time you overdraft.
Something super fun that banks do is they rearrange your charges every day so that the largest ones are at the top, ensuring you get hit multiple penalties for each of the smaller charges. In 2019, banks collected almost $12 billion in overdraft fees, 84% of which came from the poorest 9% of customers. Well, that's not great, but at least your bank is conveniently located and you can go talk to someone. Actually, no, just like with food deserts, you've probably heard about banking deserts. Yes, many banking deserts are in rural areas where there is perhaps literally nothing for miles, let alone a bank. I grew up in Idaho. I know what it's like to have nothing but rocks for miles. But according to NPR, banks closed more than 3,000 branches in 2020. Now many cities like Baltimore and Chicago have communities that don't have easy access to a bank. But you can do your banking online with your smartphone, right, Bro?
Brokamp: Well, that's easier said than done, especially for lower income Americans. The Pew Research Center released a report in June, which found that about a quarter of adults with household incomes below $30,000 a year said they don't own a smartphone, 41% don't have a desktop or laptop computer, and 59% don't have a tablet of any kind. That's what makes it very hard to do any online banking. What do you do if there isn't a bank nearby, you don't have easy access to the Internet? You turn to ATMs. Now, ideally, people use banks that offer plenty of their own in network, no-fee ATMs in their area. Otherwise, you have to pay out of network fees, which according to the bank rate is $4.64 per withdrawal on average. If you withdraw $100, you're losing almost 5% to fees. Lower income Americans are more likely to make smaller withdrawals, which means they're paying a higher percentage of the withdrawal to these fees. Of course, to make a withdrawal, you first have to put money in your account. If there's not a bank in your area, then again, you may have to turn to ATMs, but not every ATM accepts deposits, and it can take a few days for an ATM deposit to clear and show up in an account.
Southwick: You know what, Bro, forget a traditional bank, there must be other options. You have bills to pay. You can spend $1 each for money orders. Let's say you have about a half dozen bills to pay a month, that's $72 extra you have to shell out every year just to pay your bills. If you need to cash your paycheck, check-cashing places charge you 1-2%. That's immediately dropped off the top of your take-home pay. If you have an emergency to cover or not enough money coming in, payday lenders are here to help you bridge that financial gap, which are going to cost you about $15 for every $100 you want to borrow. Of course, then if you aren't able to pay that back on time, well, that debt is going to spiral into a financial wonder hell.
Brokamp: That is absolutely for sure. According to a 2016 report from The Pew Charitable Trusts, 12 million Americans take out payday loans each year. Most borrowers pay more in fees than they originally borrowed. According to the report, the average payday loan borrower is in debt for five months of the year, spending an average of $520 in fees to repeatedly borrow $375. There are plenty of examples of even bigger numbers. Money magazine published an article about Elliot Clark, a Vietnam vet who took out five payday loans for a total of $2,500 after his wife's medical emergency led to bills and loss of income because she couldn't work anymore. It took them five years to pay off those payday loans, and they ultimately paid $50,000 in interest.
Southwick: There are about 55 million unbanked or underbanked American adults out there per the Federal Reserve, representing about 22% of all households. There is some hope though as more banks and non-profits have started to focus on making banking more accessible. Honestly, I don't blame banks for closing branches or shuttering ATMs when foot traffic dries up. Now, unfortunately, while making banking more accessible will help, it isn't going to solve the problem. As Marla Blow, Senior Vice President in Mastercard Center for Inclusive Growth said on Fool Live last year --
Marla Blow: "Where we have fundamental mismatch between the length of a month and the length of somebody's money, that technology cancels for. That's where we need bigger and different kinds of interventions, and whether that's employers thinking about their role in our society and in our economy differently, whether that's the labor department deciding to get involved at the state and federal level and addressing some of the shifts in what minimum wage ought to be and how much it takes to make the month work or make the year work. I recently read a statistic that said, it takes 53 weeks now of full-time employment to cover the basic expenses in a household. I don't have to tell this audience what 53 weeks means. There's some structural fixes that are probably needed alongside the technology innovation to make it all come together."
Southwick: Putting numbers to our point, a full-time employee making the federal minimum wage of $7.25 an hour is going to earn about $15,000 a year. If they are a single mom supporting a kid, then they are still earning a couple thousand dollars below the poverty level for a family of two. To sum it up, I'll quote the comedian Chris Rock, "Wealth is not about having a lot of money, it's about having a lot of options." When you are poor, regardless of how you got into that position, you have way fewer options on where you can shop, bank, and live. Those available options are usually lousy. Then the negative consequences of those lousy options financially compound over and over, and the hole you have to dig out of becomes deeper and deeper. If you have wealth, be thankful for your options.
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Brokamp: The No. 1 goal for investors is retirement. But how much should you be saving and how do your current savings compare to where you should be at your age? These aren't easy questions to answer, but fortunately, some experts have run the numbers and come up with some general guidelines. Here to talk about some of those guidelines is Roger Young, Certified Financial Planner Practitioner and a Senior Retirement Insights Manager for Individual Investors at T. Rowe Price. Roger, welcome to Motley Fool Answers.
Roger Young: Robert, thanks for having me.
Brokamp: Why not very quickly just go through the general guidelines that have been produced by your research and that at T. Rowe Price and their savings benchmarks measure as a multiple of your household income? Just starting at age 30, T. Rowe Price research indicates that you should have half of your household income saved up. For example, if you make $100,000, you should have $50,000 saved. Then it just goes up from there. I'm just going to read them very quickly. Age 35, you should have one time your household income; age 40, two times; 45, three times; age 50, five times; age 55, seven times; age 60, nine times; and then age 65, the point of retirement. Generally speaking, people should have 11 times their household income saved before they quit work. My first question is, how did T. Rowe Price develop those benchmarks?
Young: Well, we started with the end goal in mind, how much money you're going to need at retirement, that 11 times number you just mentioned. Right off the bat, I do want to clarify one thing. Those are the mid points of ranges that we've developed. There's actually a fairly wide range, especially at retirement and as you approach retirement. For example, at retirement, we think that that range for many people is between around 7.5 times income and 14 times income, so pretty big range. It depends on a lot of factors. The biggest one though is your income. That's because of how Social Security benefits are calculated as the primary reason. We came up with that 7.5 to 14 times range, around 11 in the middle. Then we worked backward from that point to find what we thought were reasonable paths for people to get there. As you mentioned, we cranked the numbers. We had a lot of assumptions, including returns, but we wanted to be reasonable with it. We didn't want to assume that everyone can start saving 15% of their salary right out of the gate in their early 20s. We had a little bit of a different assumption than maybe some other people use there. The idea was to be realistic. We don't want to give people a false sense of confidence. We also don't want people to get discouraged and say, "How can I get to that number when I'm 30 or 35?"
Brokamp: That's an interesting part about your benchmarks when you're compared to Fidelity. Fidelity is pretty well-known. Fidelity thinks that someone at age 30 should have one times their household income, whereas T. Rowe Prices have that. Fidelity got some flak about that, especially for younger people who have student loans and things like that.
Young: Sure.
Brokamp: Feeling like it's just not realistic, whereas yours are, I think, a little bit more realistic. You're starting off with people saving 6% and gradually moving up to about 15%. Am I understanding that correctly?
Young: Correct. Then we say 6% at age 25. We acknowledge people have student loans, people are trying to build an emergency fund, people might be saving for a house, and that this can happen at any time in your life. But especially when you're just getting out of school, those are our common goals that for a lot of people take priority over retirement, which is an abstract concept 30, 40 years down the road.
Brokamp: These benchmarks obviously have to be very general. You do mention that there are ranges, so how does someone go about adjusting these to make them more relevant to their individual situation?
Young: Well, first, we did try to address the biggest variable, your income. If you look at our articles on it, you will see more specific benchmarks for people approaching retirement based on their income, and also factoring in their marital status. Just as an example, at age 65, if you're single, if you're only earning $75,000, our approximate benchmark for you is to get to 10.5 times your income. Whereas if you're a single person earning $250,000, we think that target should be at the high-end, the 14 times. That's the first big way to customize this a little bit. Beyond those factors, there are certainly other ones to consider. For example, our assumption is that you're going to cut your spending a little bit in retirement, and we start with cutting 5%. If you expect to spend more than that or less than that, you should tweak your targets a little bit. We also assume that your retirement savings are all in tax-deferred accounts, so a traditional IRA or a traditional 401(k). If you have a lot of your savings in Roth accounts or increasingly popular HSA accounts, those potentially are tax-free in retirement, so you could reduce your targets a little, but those are tweaks around the edges. There we're starting to get into a lot of details, and that means you should really go beyond these rules of thumb or even these customized rules of thumb. There are online tools available like our retirement income calculator, and obviously, financial professionals can help you develop a plan that's more tailored to your situation.
Brokamp: If people read the reports that you've produced, they'll find other ways to customize them and one of them is that one of the reports indicates that single workers have to save more than married workers. Why is that?
Young: That's true at the same household income level for people, and it's largely because of Social Security benefits. For example, a single person earning $100,000 gets a fair amount less on Social Security benefits than a couple where each spouse is earning $50,000. Social Security helps you less, relatively speaking, as you earn more. So the single person needs to save more. If you look more carefully at our table of benchmarks that I mentioned, you'll see that the targets for a single person earning $75,000 are the same as for a dual income couple earning $150,000. In that sense, they're similar, it's just comparing one person earning $75,000 to two people earning $150,000 in total.
Brokamp: Another way to look at the whole retirement savings conundrum is just to ask what percentage of income household should be saving. You've mentioned 15%, is that the official amount from T. Rowe Price that people should be aiming for?
Young: Yeah. That's the guidance that we give to most people. Our research analysis has found 15% is a good target for most people. Now, I should highlight that number includes any employer contribution you get. If your employer is kicking in 3%, you would want to aim for 12% on your own. Now, if you are a high earner, you probably want to aim higher than 15%, maybe 20% or even more. Again, that's because the benefit of Social Security keeps going down as you get into higher income levels relative to your income. High-income people are also in a good position to do what I suggested earlier, to use some more sophisticated planning to work with a financial professional instead of just relying on a rule of thumb.
Brokamp: Are there any other aspects of retirement planning that you think don't get enough attention?
Young: I do a lot of work on tax efficient retirement planning. One example of that would be how to manage different types of accounts, traditional accounts, Roth accounts, taxable accounts. How to manage them leading up to retirement, how to manage them in retirement, how to take money out of different accounts in an efficient way. I wouldn't claim that it doesn't get attention, that topic certainly gets some attention from people in the financial services world. But it's something that can be really challenging for people to understand, and to implement effective strategies. My advice on that would be at some point, you probably want to work with a financial professional if your situation gets more complex than just having a traditional account, for example. That professional can help you clarify your vision for retirement, and an action plan to get there. Rules of thumb are very helpful but as you get too close to retirement, you really want a plan that reflects your situation, and your own goals.
Brokamp: I totally agree with that. I've said on the show frequently that I think everyone should check-in with a financial planner certainly after age 50 to make sure that you're on track, and then when you're within a few years of retirement. Because I imagine that many people, even though they're dedicated to 'do it yourself,' there's something that they haven't quite thought of that a financial planner can point out.
Young: Sure. They might have things in pretty good shape, but they don't know what questions to ask that they've missed. That's absolutely a possibility.
Brokamp: Well, those are all excellent points, Roger. If you, dear Answers listener, want to read more about retirement savings benchmarks, visit T. Rowe Price's website, click on Insights, and then on Retirement Planning. You know how I love online tools, so I will second Roger's recommendation to give T. Rowe Price's retirement income calculator a try. Roger, thank you for joining us on Motley Fool Answers.
Young: Thanks so much for having me.
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Southwick: It's time for Answers answers, and this week's question comes from Hannah, "I'm turning 30 this year and already have more than $115,000 in retirement savings. I've been very fortunate in my pursuit of a career in STEM, and finding helpful resources such as The Motley Fool. Unfortunately, my older sister has not had the same luck. She's a teacher in the area with a high cost of living, and due in part to mental illness, struggles with managing her finances. At 32 she has nothing saved. Since I have a higher income, and I'm stronger at budgeting and savings, I want to find a way to facilitate getting her started. I've heard you talk on the show about people opening investment accounts for their children, and I wondered if there's something like this for siblings or is there such a thing as a joint IRA so that I could help her stay on top of making regular contributions, and possibly contribute myself?" Wow, Hannah. What a sister. You're putting all sisters in history to shame.
Brokamp: Yeah. Really, truly congrats to Hannah on doing really for such a good job of saving for yourself but then also the additional kudos for wanting to help out her sister. Now, last week, we interviewed Geoff Sanzenbacher of the Center for Retirement Research, and we discussed how more than 50% of those age 85 and older suffer from some cognitive decline that can have an impact on their ability to manage money. But Hannah's question raises an important point, in that many people have friends and relatives of all ages who struggle with money management. Could be due to middle illness, addictions, bad habits or just frankly just a lack of knowledge and interest.
So, what can people like Hannah do? Well, first of all, it's a lot easier if the person in need is willing to accept help. If so, Hannah's sister could give Hannah power of attorney over any, and all of our accounts, which would allow Hannah to do anything her sister could, including making contributions and investment decisions. It would also allow Hannah to keep an eye on the accounts to make sure her sister isn't making earlier withdrawals, bad investments or anything like that. A lawyer can drop a power of attorney for you. But if it's just for like one or a few accounts, I'd first reach out to the banker brokerage to see if they have a form that they prefer to use. Hannah asked if there is such a thing as a joint IRA, and the answer is no, after all, the I in IRA stands for individual. But with a POA, power of attorney, Hannah could open an account, and transfer money from her sister's bank account to the IRA. Some forms might also allow Hannah just to directly contribute to her sister's IRA, but I would check beforehand. In some cases, Hannah might first have to give the money to her sister, and then have it moved to the IRA. That's it.
Before opening an IRA, I check out the 403(b) to see if it offers a match, and decent investment choices. 403(b)s are less likely to have a match than 401(k)s, but some do, so you should check anyhow. When it comes to where to save money for retirement, you should always take full advantage of a match before contributing to an IRA. Also, since Hannah's sister is a teacher she might be covered by a traditional defined benefit pension, so basically, her employer is essentially saving for retirement for her, which is great for people who aren't as capable of or interested in managing their money. Now, if Hannah's sister isn't willing to accept help, then the most that Hannah can do probably is, and this is only at she has the spare funds herself is to maybe set up a brokerage account on her own that she invests in and that she can eventually give to her sister when she feels it's appropriate. That would have to be a regular taxable brokerage account because you can't gift an IRA without first taking out the money and then paying taxes and maybe penalties. Finally, Hannah should also have a conversation with her parents so that the state plan takes into account her sister's mental illness. This could be a case where trust is appropriate, so instead of Hannah's sister eventually inheriting all the money all at once, the trust will control how it's invested, and how much is distributed every year. So again, kudos to Hannah, and really to all Fools who are trying to help their family members be smarter, happier, and richer.
Southwick: Well, that's the show. It's edited quietly by Rick Engdahl. Our email is [email protected]. For Robert Brokamp, I'm Alison Southwick, stay Foolish, everybody.
