Saving enough for retirement is one of the biggest financial challenges that people face. It's tough to tie up large percentages of our income for decades when there are so many things we could be spending it on today. But there's a tool many employers offer that can make saving enough for retirement far easier: auto escalation.
How auto escalation works
When they first sign up for the company 401(k) plan, many workers pick a small percentage to contribute – often limiting themselves to just enough to max out the company match – and then never revisit their contribution level. After all, if you're earning just enough to get by, you're not likely to decide to set aside yet more of your money for retirement.
Auto escalation gradually and automatically increases your 401(k) contribution each year until you hit the preset cap. Many auto escalation plans will increase your saving rate by 1% per year until you're saving 15% of your income -- the percentage recommended by many retirement experts. However, check with your HR representative to find out what percentages your own plan uses.
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The benefits
With auto escalation, you don't need to make a conscious decision to save more -- the plan takes care of it for you. And since many people get raises that are greater than 1% per year, having this much additional money transferred into your 401(k) account will usually still allow your disposable income to grow every year. Plus, auto escalation helps you to increase your contribution level over time, which means that your savings will grow more quickly. Many workers feel that they couldn't possibly contribute as much as 15% of their income, but because the auto escalation plan works so slowly, the increase is painless.
The drawbacks
The auto escalation ramp-up works great if you start it early, such as just out of college. However, if you start a new 401(k) later in your career with a low contribution percentage, auto escalation won't increase your contribution quickly enough to keep you on track to save enough for retirement. The danger is that having signed up for the auto escalation plan, you'll think that you've done all you need to do -- when in fact you're falling further behind every year on your goals.
Also, if you're stuck in a pay freeze for several years running, auto escalation could ramp up your contribution enough to make you feel a bit of a squeeze on your income, especially if high inflation puts further pressure on your dollars.
Should you sign up for auto escalation?
If your employer offers an auto escalation plan, by all means go for it. However, if you're beyond your 20s, make sure that you start out at a reasonably high contribution percentage so that you don't lag behind on your savings. If you're in your 30s and can start your contribution level at 10%, you'll be doing extremely well.
If you're in your 40s or 50s, forget about auto escalation. In that case, it's better to jump to a 15% contribution rate (or even higher) as quickly as possible, especially if you don't have much saved up at this point. Be sure to run the numbers on a retirement calculator so that you can see for yourself if your contribution level is adequate.
