401k Auto Escalation Beats Inertia
In 20 years of working with 401k plans and participants – as well as individual private clients – I’ve seen a lot of 401k plans. Well over 90% of participants contribute far less than 10% of their pay. Most only putting in a paltry 5% or 6% to get whatever company match that may be available.
Enter the 401k auto escalation feature to solve the problem!
Inertia is described as the tendency to do nothing. If you do nothing, nothing changes. If nothing changes participants won’t be ready to retire. This is a massive problem for workers today.
There’s discussion in Congress to make all 401k plans automatically enroll and escalate. This may stop the inertia of workers doing nothing at all.
The 401k auto escalation feature beats inertia! It makes participants either contribute more or opt out of the increased contribution amount.
How does 401k auto escalation work?
Let’s say your 401k plan is set up to automatically enroll workers at 5% of pay (most auto-enroll at much lower rates). That 5% of pay is better than nothing, so we’re starting off well at least.
Over the years, workers compensation tends to rise. As worker comp rises, that 5% rises (in dollar terms) with it.
The original problem – not saving enough for retirement – still exists however. 10% should be an absolute minimum savings rate. How do we get workers to that 10%? Auto escalate their 401k contribution rates!
401k auto escalation benefits
By automatically increasing the percentage workers save by 1% or 2% per year, the employee won’t feel it as much as contributing 10% right off the bat. They’ll get closer to reaching their retirement savings goals this way.
Auto escalation can take place at the beginning of each year, allowing a full 12 months for the participant to manipulate their savings rate prior to years end.
The 401k auto escalation feature can be set up to cap out at 10% or more (or less). It all depends on what’s appropriate for your plan, and your participants.
Since 10% is the absolute minimum a worker should be saving towards retirement, consider a higher cap than 10%. The employee participant can opt out each year if the savings ratio to paycheck becomes too burdensome.
How Many 401k Plans Are Auto-Escalating?
62% of plans over 200 million in assets are using the auto enrollment feature. Only 48% of all plans use the auto escalation feature according to the Society for Human Resource Management article here.
The reasons more plan sponsors don’t use auto escalation? They feel it’s too paternalistic, employees would complain, and it can get expensive from a matching perspective.
The fact is there’s a 401k education problem here as well. Most employers don’t put enough pressure on 401k plan advisors to provide greater educational assistance with financial and retirement planning.
My hope is that over time this will change, because the retirement savings crisis we’re facing in America won’t unless we figure out how to beat participant inertia!