When signing up for benefits this year, you may notice something different when it comes to your 401k contribution – opt-out auto-escalation. Confused? It's the idea that employees need to decide NOT to join the 401k and NOT to increase contributions each year, rather than opt in.
When enrolling in your benefits, you'll notice something similar to this:
Increase contributions each year by:
- Don't Increase
When you see that, chances are the circle next to 3% is already highlighted, and you have to choose to change it.
Why Auto Escalation Matters
The goal of auto escalation is simple: to increase the amount you contribute to your 401k each year. That sounds like a pretty good thing right? And it is, and most 401k plan administrators think so as well.
Just think about it this way. You start with a 5% contribution to your 401k, with a 1% increase. Well, if you are getting a pay raise each year – say 3%, you probably won't even notice the increase to your 401k contribution. And then, over time, your 401k grows with even more momentum due to the increased contributions.
The Fear of Auto Escalation
However, there is one main drawback – fear from plan participants. I know when I saw this, I immediately thought “I don't want to increase contributions because I can't afford to”. My initial reaction was to be scared and not setup my 401k plan to increase each year. And many employees fall into this category.
That's why many plans are now moving to automatically choosing auto escalation unless you opt out. In a recent study by Fidelity, 46.6% of 401k plans had opt-out, while 49.7% had opt-in auto escalation. So, while more still require you to sign up, many are moving towards the auto enrollment of it as well.
Plus, only 3.7% of plans DON'T offer auto escalation at all. So the option is there for most employees.
Should You Consider It?
Yes. Auto escalation offers a great way to boost your savings each year without feeling like you're compromising your spending money and take home pay. If you have a job where you get annual raises, I would set your auto escalation amount by 1-2% less than your typical raise.
If you get a 5% annual raise, setup your 401k auto escalation amount to be 3%. If you get a 3% annual raise, make it a 1% auto escalation amount.
That way, when you get a raise, not only are you saving more to your 401k, but you also get to take home a little more pay as well. That lets you pay yourself now and pay yourself for the future.
The only time you might not want to consider auto escalation is if you're not satisfied with you 401k plan. For example, if you don't receive a company match, or have poor investment choices and would prefer to leverage a Roth IRA or other retirement account. Then, save more elsewhere and don't auto escalate your 401k.