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You may be saving more money for retirement and not even know it.
More employers are automating the way people save in their company’s 401(k) plans to overcome the inertia that often prevents us from building a nest egg.
“Automatic escalation” – or auto-escalation for short – is one of these popular mechanisms.
This automatically increases employees’ savings rates each year, often by 1 percentage point at a time up to a cap. The aim is to boost savings when workers may not take action themselves.
However, for many people, the amount of extra money that comes from each paycheck may not be apparent.
“I bet they don’t realize it,” said Ellen Lander, founder of Renaissance Benefit Advisors Group based in Pearl River, New York.
In general, though, it’s a good thing.
In an ideal world, workers would save at least 15% of their annual wages in a 401(k) plan, Lander said. This includes both personal contributions and employer contributions such as a company grant. The ideal interest rate can vary depending on factors such as age and external savings.
“Philosophically, I think automatic escalation makes perfect sense,” Lander said. “We want people to save as much as possible.”
Automated 401(k) savings are more widespread
In addition to automatic enrollment, automatic escalation has also become more widespread, in which employers divert a portion of employees’ paychecks into a 401(k) account if they do not voluntarily enroll.
About 64% of companies with a 401(k) plan automatically enrolled employees in 2022, according to an annual survey by the Plan Sponsor Council of America, a trade group.
According to the survey, 78% of these companies also automatically increased employee savings, up from 65% in 2013.
Most, or 84%, of these 401(k) plans increase employee savings rates by 1 percentage point per year.
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Here’s a basic illustration of how it works: Let’s say an employee earns $75,000 per year, contributes 6% of their annual salary to a 401(k), and receives their salary twice a month. This person saves $4,500 per year, or $187.50 per paycheck.
By increasing the savings rate to 7%, the annual savings amount to $5,250, or $218.75 per pay cycle – which is just $31.25 more per paycheck.
(This example does not take into account additional financial factors such as taxes or annual salary increases.)
Employees can object to the agreement. Employers are also required to send employees a notice informing them that they will be automatically enrolled in a 401(k) program and their savings rate will be increased. However, such communications may go unnoticed.
Many companies are hesitant to implement automatic escalation at all because they fear it could be “burdensome” and put too much financial strain on some workers, Lander said.
According to data from the Plan Sponsor Council of America, only 40% of 401(k) plans that use auto-enrollment automatically increase savings for all workers. About 12% do this only for investors who “under-contribute.” And 26% make escalation a voluntary employee decision, while 22% do not offer it at all.
The vast majority of 401(k) plans do not automatically increase savings above a cap, and nearly two-thirds, or 63%, limit these automatic employee contributions to 10% or less of annual wages.
Of course, reaching the cap doesn’t necessarily mean that workers are saving enough. Employees can voluntarily set their savings rate higher.
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2024-05-24 16:21:20
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