As more and more employers look for ways to help their employees save for retirement, auto-escalation has become a popular mechanism in company 401(k) plans. This feature automatically increases workers’ savings rate each year, typically by 1 percentage point at a time, with the aim of overcoming the inertia that often hinders individuals from saving enough for their retirement. Although the intention behind auto-escalation is noble, many employees may not even realize that their contributions are being gradually increased. Ellen Lander, founder of Renaissance Benefit Advisors Group, believes that most workers are unaware of this automatic adjustment in their savings rate.
The Benefits of Auto-Escalation
Ideally, experts recommend that individuals save at least 15% of their annual pay in a 401(k) plan, including both personal contributions and employer matches. However, the actual amount one should save may vary depending on factors such as age and existing savings. Auto-escalation, in this regard, makes perfect sense as it encourages people to save as much as they can towards their retirement. The slight increase in savings rate each year may seem insignificant, but it can have a significant impact on one’s overall retirement nest egg in the long run.
The widespread adoption of auto-escalation in 401(k) plans has been accompanied by the practice of automatic enrollment, where a portion of an employee’s paycheck is diverted into their retirement account if they do not voluntarily sign up. According to the Plan Sponsor Council of America, about 64% of companies with a 401(k) plan automatically enroll workers, with 78% of them also implementing auto-escalation features. Typically, these plans raise workers’ savings rate by 1 percentage point each year, incrementally increasing their contributions without requiring active participation.
To illustrate the effect of auto-escalation, consider a scenario where a worker earning $75,000 per year contributes 6% of their annual salary to a 401(k) plan. By raising the savings rate to 7%, the annual savings increase from $4,500 to $5,250, with a minimal impact of just $31.25 more per paycheck. While these incremental changes may not be immediately noticeable, they play a crucial role in enhancing long-term retirement savings. It is important to note that employees have the option to opt out of auto-escalation if they choose to do so.
Challenges and Concerns
Despite the benefits of auto-escalation, some companies are hesitant to implement this feature due to concerns about imposing a financial burden on their employees. Among 401(k) plans that utilize automatic enrollment, only 40% automatically escalate savings for all workers. Additionally, around 26% of plans make auto-escalation a voluntary choice for employees, while 22% do not offer it at all. Moreover, most plans do not raise savings beyond a certain cap, with nearly two-thirds limiting automated worker contributions to 10% or less of their annual pay.
Auto-escalation is a valuable tool that can help individuals save more effectively for retirement. By gradually increasing savings rates over time, employees can maximize their long-term financial security without having to actively monitor and adjust their contributions. While there are challenges and concerns associated with auto-escalation, the overall benefits of this feature outweigh the potential drawbacks. It is essential for both employers and employees to understand the impact of auto-escalation on retirement savings and consider implementing or enrolling in this program for a more secure financial future.