Why you might be saving more in your 401(k) — and not even know it

You may be saving more money for retirement without even knowing it.

An increasing share of employers are automating the way people save in their company’s 401(k) plans, in an effort to overcome the inertia that often prevents us from building savings.

“Auto-escalation” – or auto-escalation for short – is one of those popular mechanisms.

It automatically increases workers’ savings rates each year, often by 1 percentage point at a time, up to a ceiling. The idea is to stimulate savings when employees may not take action themselves.

However, the amount of extra money that comes from each paycheck can be invisible to many people.

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

Overall, though, it’s a good thing.

In an ideal world, employees would save at least 15% of their annual salary in a 401(k) plan, Lander said. This includes both their own contributions and employer contributions such as a company match. The ideal rate may fluctuate depending on factors such as age and external savings.

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

Auto-escalation has become more widespread alongside auto-enrollment, in which employers roll over a portion of employees’ paychecks into a 401(k) if they don’t voluntarily enroll.

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

Of these companies, 78% also automatically increased their employees’ savings, up from 65% in 2013, the poll found.

Most (84%) of these 401(k) plans increase employee savings rates by 1 percentage point per year.

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

Increasing the savings rate to 7% results in annual savings of $5,250, or $218.75 per pay cycle – which equates to just $31.25 more per paycheck.

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

Employees can unsubscribe from the scheme. Employers are also required to send a notice to employees communicating that they will be automatically enrolled in a 401(k) and that their savings rate will be increased, but such communiqués may go unnoticed.

Many companies are hesitant to adopt auto-escalation altogether because they fear it could be “burdensome” and place too much of a financial burden on some employees, Lander said.

Of 401(k) plans that use automatic enrollment, only 40% automatically result in savings for all employees, according to data from the Plan Sponsor Council of America. About 12% only do this for investors who ‘contribute too little’. And 26% make escalation a voluntary choice for employees, while 22% do not offer it at all.

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

Of course, reaching the limit does not necessarily mean that employees are saving enough. Employees can voluntarily set their savings rate higher.