Why You May Be Saving More in a 401(k) Without Even Knowing It

You may be saving more money for retirement and not even know it.

More employers are automating the way people save money in their company 401(k) plans, aiming to overcome the inertia that often prevents us from building savings.

“Automatic escalation”—or auto-escalation for short—is one such popular mechanism.

It automatically raises workers’ savings rate each year, often by 1 percentage point at a time, up to a maximum level. The goal is to help increase savings when workers are unable to act independently.

However, the amount of extra money coming in from each paycheck may not be noticeable to many people.

“I bet they don’t realize it,” said Ellen Lander, founder of Renaissance Benefit Advisors Group, based in Pearl River, New York.

However, overall it’s good.

In an ideal world, Lander says, workers would put at least 15% of their annual salary into a 401(k) plan. This includes both their own contributions and employer contributions, such as company contributions. The ideal rate may fluctuate depending on factors such as age and outside savings.

“Philosophically, I think auto-escalation makes sense,” Lander said. “We want people to save as much as possible.”

Automatic escalation has become more common along with auto-enrollment, where employers divert a portion of workers’ paychecks into a 401(k) if they don’t voluntarily enroll.

About 64% of companies with 401(k) plans automatically hired workers in 2022, according to an annual survey by the Plan Sponsor Council of America, a trade group.

Of those companies, 78% also automatically increased employee savings, up from 65% in 2013, according to the survey.

The majority, or 84%, of these 401(k) plans increase workers’ savings rate by 1 percentage point per year.

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Here’s a basic illustration of how this works: Let’s say an employee makes $75,000 a year, puts 6% of their annual salary into a 401(k), and gets paid twice a month. This person saves $4,500 per year, or $187.50 in salary.

Increasing the savings rate to 7% increases annual savings to $5,250, or $218.75 per pay cycle, which is just $31.25 more per paycheck.

(This example does not take into account additional financial factors such as taxes or annual salary increases.)

Employees may refuse the agreement. Employers are also required to send notice to employees that they are automatically enrolled in a 401(k) and their savings rate will be increased, but such messages may go unnoticed.

According to Lander, many companies are hesitant to add automatic escalation at all because they fear it could be “onerous” and place too much of a financial burden on some workers.

Among 401(k) plans that use automatic enrollment, only 40% automatically increase savings for all workers, according to the American Council of Plan Sponsors. About 12% do this only for investors who are “undercontributing.” And 26% consider escalation to be a voluntary choice of employees, while 22% do not offer it at all.

The vast majority of 401(k) plans do not automatically allow savings to grow beyond a set limit, and nearly two-thirds, or 63%, limit automated contributions to 10% or less of annual salary.

Of course, hitting the cap doesn’t necessarily mean workers are saving enough. Employees can voluntarily set a higher savings rate.