Embrace auto-escalation and raise the cap
Too many plan sponsors are afraid of auto-escalation and set their contribution caps too low. One objection that frequently arises: “I don’t want to upset employees.” The fear is that an imagined employee will discover that a higher percentage of their paycheck is being channeled into their retirement account than they expected.
Anecdotally, employees are rarely upset about auto-escalation, and they may be surprised when they hit the cap. Of course, most people are pleased when they discover a higher-than-expected balance in their 401(k)s, and the “problem” of an upset employee can be solved with a few clicks of a button. If they want to reduce their contribution, that is an easy fix.
A much greater risk is to your plan participants’ savings goals. People are often inclined toward inertia and underinformed about retirement savings needs. Left to their own devices, they’re likely to assume that their current contribution rate, whether it’s 3%, 6% or something else, will help them reach their goals. Fortunately, you have tools to leverage this inertia and help them overcome their own misinformed confidence. Auto-escalation provides this power, yet some sponsors are reluctant to use it to its full extent. This is particularly true when it comes to capping the escalation rate. I’ve seen sponsors set caps as low as 6%.
Auto-escalation has no generally applicable IRS limit, though guidance on the niche case of auto enrollment safe harbor plans has affected perception. Thanks to the SECURE Act of 2019, plan sponsors with an automatic enrollment safe harbor plan can increase the auto-escalation cap up to 15%. It’s promising to see in the Callan Institute’s 2022 Defined Contribution Trends Survey that 27% of safe harbor sponsors intend to increase their cap to the maximum. Conversely, it is disappointing to see 31% intend to make no increases whatsoever.