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.
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.
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.