According to the Consumer Federation of America, 56% of Americans are not saving at a sufficient rate to ensure a comfortable retirement. Part of the problem stems from a lack of participation in employee 401(k) retirement savings plans, as well as low contribution rates even by those who do participate.
The solution is for companies to implement a four-step 401(k) plan enhancement, typically called “Escalation and Allocation.” The first step (already used by about 8% of all companies with 401(k) plans) is to implement automatic plan enrollment, whereby new employees will be enrolled in the plan unless they go to the effort of opting out. Second, the plan will automatically escalate their contribution percentages as their pay levels increase over time. Third, as employees age, the plan automatically shifts their contributions into a different mix of more conservative investments. Finally, if an employee ever leaves the company, the plan automatically rolls over their contributions into a tax-deferred account, so they do not lose funds to tax penalties.
Automated escalation and allocation is already offered through the Principal Financial’s Step Ahead program (where employees individually choose the rate of escalation to which they will be subjected), as well as Vanguard’s One Step program. Most 401(k) plan administrators do not yet offer formal escalation and allocation programs. However, it is entirely possible to build these provisions into the existing 401(k) plan, with (admittedly tedious) manual administration of all periodic changes.
Unlike the usual best practices that I list in this newsletter, this recommendation does not save a company any money. Nonetheless, it is a clear case of doing the right thing, since the organization is looking out for the retirement prospects of its employees. Also, there is a modest up-side to automated escalation and allocation – by including nearly all employees in the 401(k) plan, it is much less likely that a company will fail its annual discrimination tests. Consequently, if a company has a history of failing these tests or of restricting contributions by highly compensated employees (HCEs) in order to pass the tests, implementing this best practice means that HCEs can probably contribute more money to their 401(k) accounts.