I met with Lauren recently, a mid-career employee in her thirties who wanted to know if she was on track for retirement. I asked her how much she was contributing and she told me 6%, which is the minimum to capture the full match from her employer, and the default deferral that she was auto enrolled with when she got hired two years ago. However, when she handed me her latest retirement account statement, her actual salary deferral was at 8%.
So why had she told me the lower amount? Well, what Lauren had forgotten was that her auto enrollment into her 401(k) back in 2009 also included an auto increase, or step-up, of an additional 1% a year on top of her initial 6% deferral. And guess what? She never even noticed the increased deferral rate’s impact on her paycheck!
To show her the big difference that the small increase in savings meant to her, I ran a retirement projection using 3 different scenarios. Scenario 1 was based on her automated step-up that stops when she reaches 10%, scenario 2 continues the step-up contributions until she reaches 15% deferral, and then scenario 3 we based on her doing just the minimum to capture the employer match.
Which scenario do you think had her achieving retirement readiness at age 65 with 80% income replacement based on a $50,000 income and a moderately aggressive portfolio?
Scenario 1
- Initial deferral 6%
- Auto increase up to 10%
- Projected balance of $775k
- Projected 70% replacement*
Scenario 2
- Initial deferral 6%
- Auto increase up to 15%
- Projected balance of $920k
- Projected 87% replacement*
Scenario 3
- Initial deferral 6%
- No deferral increase
- Projected balance of $610k
- Projected 50% replacement*
*Includes Social Security benefits and 401(k) distributions
More companies are adding this automatic contribution step-up feature, according to 2011 401(k) Benchmarking Survey that is co-sponsored by Deloitte and the International Foundation of Education, Benefits, and Compensation. Almost half of the companies that took part in the survey now use this automatic approach to increasing participant savings, and 45% take a proactive view and make the step-up feature a default option for new enrollees. The most common default incremental step-up percentage was reported to be 1%.
Unfortunately, for employees that must voluntarily opt in to this feature, the number of participants utilizing the step-up contribution remains low. Nearly two-thirds of the plan sponsors who offer the step-up indicated that the feature is used by less than 10% of their participants. Only 15% of plan sponsors believe their workforce will be prepared for retirement, and yet 64% of those same plan sponsors feel they have an obligation to prepare employees for retirement. It seems to me that more employers should explore establishing the step-up feature as a default option through automatic enrollment, which will help enable employees to save more for retirement. Lauren was a perfect example of the difference a few percentage points can make.