When signing up for benefits this year, you may notice something different when it comes to your 401(k) contribution: opt-out auto-escalation.
Confused? It’s the idea that employees need to decide not to join the 401(k) 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 401(k) each year. That sounds like a pretty good thing, right? And it is, and most 401(k) plan administrators think so as well.
Just think about it this way. You start with a 5% contribution to your 401(k), 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 401(k) contribution. And then, over time, your 401(k) 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 set up my 401(k) 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 Investments, 46.6% of 401(k) 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 automatic 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% to 2% less than your typical raise.
If you get a 5% annual raise, set up your 401(k) 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 in your 401(k), 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 your 401(k) plan. For example, this might be 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 401(k).
Robert Farrington is America’s Millennial Money Expert® and America’s Student Loan Debt Expert™, and the founder of The College Investor, a personal finance site dedicated to helping millennials escape student loan debt to start investing and building wealth for the future. You can learn more about him on the About Page, or on his personal site RobertFarrington.com.
He regularly writes about investing, student loan debt, and general personal finance topics geared towards anyone wanting to earn more, get out of debt, and start building wealth for the future.
He has been quoted in major publications including the New York Times, Washington Post, Fox, ABC, NBC, and more. He is also a regular contributor to Forbes.