Close Close
Sign In
Newsletters
Popular Financial Topics Discover relevant content from across the suite of ALM legal publications From the Industry More content from ThinkAdvisor and select sponsors Investment Advisor Issue Gallery Read digital editions of Investment Advisor Magazine Tax Facts Get clear, current, and reliable answers to pressing tax questions
Luminaries Awards
Podcast Center Video Center Webcasts Resource Center Events
About ThinkAdvisor Contact Us Advertise With Us Asset & Logo Licensing Sitemap Terms of Service Privacy Policy Copyright © 2024 ALM Global, LLC. All Rights Reserved.
ThinkAdvisor

Retirement Planning > Retirement Investing

How to Boost Use of Retirement Plan Auto-Escalation

By Ken Waineo

X
Your article was successfully shared with the contacts you provided.

It seems that almost every day a new report is published suggesting retirement plan participants are behind in their efforts to build a sizable nest egg.

Advisors have done a great deal to help their clients act on these negative stats in recent years. This includes encouraging plan sponsors to automatically enroll employees in defined contribution plans, rather than having them opt in. By making this change, plan sponsors can help participants overcome defined contribution “inertia” by removing the participant’s need to do the legwork to enroll in a 401(k) or 403(b) plan on their own.

(Related: Retirement Outlook Improves ‘Somewhat’ as Workers Embrace Auto-Features: Survey)  

However, many of these automatic enrollment plans set a plan participant’s initial contribution rate at 3%. While 3% can be a great starting point, many plan participants assume this is an adequate savings rate and never increase their contribution amount. What these plan participants might understand is this percentage could leave them susceptible to not meeting their retirement savings goals — especially if it’s the participant’s only retirement savings vehicle.

While the majority of plan participants want to ensure they’re doing everything possible to save for retirement, many aren’t thinking of how to grow their retirement savings. To help plan participants accomplish this goal, consider how you can encourage auto-escalation as part of a plan sponsor’s overall plan design by using a few concepts rooted in behavioral finance principles.

1. Set reasonable expectations.

Behavioral finance, or the psychological biases and predispositions that can affect individuals’ financial decision-making, shows that advisors need to make retirement sound attainable for a plan participant. While many news stories and reports show that employees would need to contribute a whopping 15% or more of their paycheck each pay period to make up for a gap in savings, this can lead a participant to feel despair — and not want to do anything to help make up the gap.

Payment (Image: Thinkstock)

(Image: Thinkstock)

Encouraging a participant to contribute at least 6% of his or her paycheck is a great place to start. From there, you can have the conversation about a small escalation percentage each year, or encouraging an increase after a raise or bonus.

2. Reframe the employer match.

A plan participant may think that he or she is reaching the 6% mark after factoring in an employer match. While a participant may think of the employer match as free money, it shouldn’t be considered a substitute for putting in a full 6% of his or her paycheck. It’s important to encourage clients to contribute enough initially to receive the full employer match, or work together to set a goal to achieve that contribution rate in a certain time frame (e.g., one to two years).

For example, a common employer-matching formula is to match the employee’s contribution by 50 cents on the dollar, up to 6%. If an employee is auto-enrolled at 3%, they are only getting an additional 1.5% match from their employer and are leaving money on the table. By setting a goal of increasing to 6%, they can look forward to getting the maximum 3% contribution from their employer.

3. Showcase monthly income projections instead of account balances.

Another way to drive home the importance of auto-escalation is by showing employees how much of their working income they’re projected to replace during retirement, instead of just focusing on their full account balance. That’s because a plan participant in his or her mid-30s who sees an account balance of $100,000 may think it’s a lot of money, and cut back on how much he or she is contributing for retirement.

To help a participant understand what his or her account balance really means, talk about their finances in terms of what their monthly income needs will be after retiring, based on current projections. A participant will have an idea of how much working income he or she will want to directly replace in retirement, which is typically going to be 50% to 80% of what they’re making now. Showing the gap between the income they will need and the income they are projected to have can help drive home the point that they need to continue to make increases throughout their career.

Getting employees enrolled in their employer’s defined contribution plan is only step one in helping your clients ensure their workforces are setting themselves up for a successful retirement. Continuing to emphasize the importance of contributions, especially through auto-escalation, can help ensure a participant is on track to replace his or her income in their post-retirement years.

— Read Future Retirees Could Be More Reliant on Social Security on ThinkAdvisor.

NOT FOR REPRINT

© 2024 ALM Global, LLC, All Rights Reserved. Request academic re-use from www.copyright.com. All other uses, submit a request to [email protected]. For more information visit Asset & Logo Licensing.