The Benefits of Auto Enrollment and Auto Escalation
No, this blog post has nothing to do with cars. It’s about features that retirement plan sponsors can implement to help their employees prepare for retirement at limited, or no, cost to the company. Our most successful retirement plans have both auto enrollment and auto escalation. How do we measure success? The companies’ employees are more prepared for retirement because they have more saved and senior executives are able to fully participate because there are no testing issues.
Auto enrollment is automatically adding employees into the retirement plan as soon as they become eligible. Most companies that utilize the auto enrollment feature enroll participants up to the amount that they match. So if an employer offers a match of 100% up to 3% they will enroll an eligible employee at 3% of compensation. The change in their net paycheck is small, but it makes a significant impact on when they can retire. For example, an employee making $50,000 per year and being paid every two weeks, enrolled at 3% would be contributing $57.69 per paycheck.
However, because it is pre-tax money, their paycheck will only decrease by about $48 plus they will get an additional $58 from you, the employer (which will be a tax deduction for you). Most employers don’t utilize auto enrollment because they are concerned how employees will react, fearing that many employees will be upset about auto enrollment. However, at a recent Plan Sponsor University we conducted at Merrimack College, we found similar results to what we had been hearing in the industry, companies that implemented automatic enrollment had less than 6% of employees opt out. The employees were notified of the enrollment and could opt out at any time, but the vast majority loved the impact once they looked at their statement.
Auto escalation is often paired with auto enrollment to help employees meet their goals. Auto escalation is gradually increasing the contribution rate for the employee. If the employee starts at a 3% deferral rate; the rate can automatically increase by 1% each year until it reaches a certain level, usually 10 or 12%. Year 2 the employee will be saving 4%, then 5%, and so on until they are well on their way to a successful retirement.
Why is this an important pairing? It is a general rule of thumb that people need to save 10-15% of their income annually for retirement, so while 3% (plus another 3% if you’re matching) is a good start it’s going to leave people well short of their retirement needs. For the same reason, that these features work, inertia, if you as the employer don’t assist them in the decision to save more, they will likely never do so, just sitting at their 3% contribution until they wake up one day in their 50’s or 60’s completely unprepared for retirement. However, since they likely get some sort of raise each year, if auto escalate is implemented to coincide with the raise cycle, they will still have more money in their paycheck and be better prepared for retirement.
Most Americans are far from being ready for retirement so anything that employers can do to help goes a long way. Retirement plans are a valuable tool to attract and retain your essential talent; we all know how much it costs to retrain new people on a regular basis and many of you want to help provide for your employees as well; these are a couple features that will help in both of those areas, at limited additional cost to them.
Let us know if you would like us to walk you through how to implement these features.