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How Auto-Escalation Can Help You Save More for Retirement

David Schepp

Americans simply aren't saving enough for retirement.

For some, it's simply a matter of not having access to a defined contribution plan, such as a 401(k). But even among workers who are offered such a benefit, many lag way behind in building a nest egg large enough to allow them to retire comfortably.

Some employers have sought to help workers save more in recent years by offering plans that automatically enroll newly hired employees in the company's retirement savings plan, as well as adopting so-called automatic contribution escalation plans that, by default, automatically raise each year the percentage of workers' pay to be invested into a 401(k) plan.

The purpose behind the auto-escalation feature is help employees overcome inertia, says Lenny Sanicola, senior practice leader at WorldatWork, a nonprofit human resources organization. Auto-escalation can be a painless way for workers to increase the amount they save each pay period. Further, many companies time the increase in 401(k) contributions to coincide with when pay increases show up in workers' paychecks, minimizing any reduction in pay.

Left to their own devices, many workers contribute only the bare minimum to qualify for any matching funds from their employer, typically just 6 percent of their pay. But Sanicola says workers easily need to save 10 percent or more of their pretax earnings to ensure an adequate nest egg.

Most employees want to do the right thing and put more of their pay toward retirement savings, Sanicola says, "but they freeze and don't take action." That can be especially true for those older than 50 with less than $100,000 set aside for retirement, who need to be saving much more.

The investor retains control. Employees shouldn't be intimidated by auto-escalation because ultimately they're the ones who control how much is set aside, says Bruce Elliott, manager for compensation and benefits at the Society for Human Resource Management. The only downside is for the employee who can't afford the increase, he says. And if a worker can't part with more salary, he or she can simply opt out.

"The employee always has control over the plan," Elliott says.

While employees benefit through increased savings, many employers remain wary of auto-escalation. A recent survey by the Defined Contribution Institutional Investment Association showed only 48 percent of employers offered plans with an auto-escalation feature in 2014, unchanged from the previous year and only two percentage points higher than in 2010, when the survey was first conducted.

According to the study, the plateau in the number of companies adopting auto-escalation was attributed to employers' concerns that doing so would be too paternalistic, too costly from a matching perspective or simply not needed, as participants' contribution rates were already high.

Features benefit companies and workers. Despite those concerns, employers also benefit from offering auto-enrollment and auto-escalation features. "All plans have to go through a discrimination test to ensure ... that not only highly compensated employees are benefiting from plan," Elliott says.

Congress mandated the tests as a way to ensure that high earners weren't the only ones to benefit from the significant tax breaks that 401(k) plans provide. Fortunately for savers, the vast majority of 401(k) plans easily pass the test.

The annual screening, administered by the Internal Revenue Service, requires employers to assess how much of the total amount held within a company's 401(k) has been contributed by all employees, including those who earned more than $115,000 or owned 5 percent or more of the company. If the amount contributed by these highly compensated employees exceeds the average of the company's non-highly compensated workers by more than 2 percent, the company could lose its tax-qualified status, and then be required to return all of the plan's money to employees.

One of the most effective ways of boosting 401(k) contributions is by offering a matching program. Employers typically contribute 50 cents to $1 for every dollar employees contribute to the plan. But costs prohibit matching much above that amount, which is why many employers have turned on auto-escalation as a way to boost participation.

Still, once they convince workers that incremental increases are a painless way to boost retirement savings, companies still need to guide workers and help them make appropriate decisions in the future, Saniacola says.

"Auto features are a great way of getting people into the plan," he says, "but employers must continue to engage employees afterward."

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