Auto-Escalation Saves You More for Retirement
It’s human nature—losing sight of long-range goals when we don’t see immediate returns. Often, saving for retirement falls prey to this human foible, which means it’s no surprise many employees are saving too little for their future retirement needs and often contribute only the bare minimum to qualify for matching funds offered by their employer. The auto-escalation feature of many employer defined contribution plans (e.g. a 40(1)k plan) can help overcome this shortcoming.
Enrolling in an automatic contribution escalation plan—also simply called an auto-escalation plan—is a painless way to avoid lagging behind in saving for retirement: at any point in the year, an employee can select to have the percentage of their salary invested in their 40(1)k automatically increased. They can set all parameters of the escalation—how much and how often their contribution increases. Often companies set automatic escalations to coincide with pay increases, minimizing any reduction in the employee’s paycheck.
This can help close the gap between what the typical employee is saving and what they should be deferring from each paycheck. Many are not saving enough to meet all of the expected and unexpected expenses they will face in retirement as they age and as the terms of Social Security change.
While utilizing an auto-escalation feature can better prepare workers for their future, there are times when un-enrolling in the feature is necessary: the company initiates a pay freeze, or a family member loses their job and increasing paycheck deferments no longer fits the employee’s budget. The worker can always opt out of auto-escalation until their income stabilizes again, but they shouldn’t delay in re-enrolling. It’s often easier to tighten your belt now and save more for the future than it is to earn more in the later years of life.
If your employer’s offered retirement plan doesn’t have an auto-escalation feature, you can create your own by using pay raises to increase your retirement savings. Whenever you receive a raise, increase your retirement contribution level accordingly so your take-home pay remains the same. Or, increase your contributions by half your raise amount.
Your goal should be to eventually contribute the maximum amount allowed by the IRS. To reach this goal, starting early is key. For example, an employee who starts auto-escalation with their retirement plan directly after college can reach 10 to 15 percent contribution limits by age 35. In contrast, employees who don’t take advantage of auto-escalation or start later may not reach that contribution level until their 40s or 50s, losing out on years of compound interest.
Furthermore, if we assume two 25 year-old employees earning $40,000 contribute six percent of their pay to a 40(1)k plan and both also receive a two percent raise each year with a six percent rate of return on their investments, by age 65 the one who enrolled in auto-escalation would have saved more than $1.1 million, while the other would have only saved $513,000.
If those numbers don’t speak for themselves, what does?