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401(k) Auto Escalation: Likely Impact on Accumulations 'Significant'

By Stephen Miller  9/22/2007

Automatically raising employees' 401(k) contributions is likely to increase their 401(k) accumulations by substantial amounts, according to new research by the Employee Benefit Research Institute (EBRI).

A report in the September 2007 EBRI Notes, "The Expected Impact of Automatic Escalation of 401(k) Contributions on Retirement Income," suggests that the introduction of automatic escalation will result in a significant increase of 401(k) accumulations -- especially for low-income workers -- compared with estimates previously determined for automatic enrollment alone. Under assumptions and scenarios modeled in the article, automatic escalation will likely increase overall 401(k) accumulations by:

11 percent to 28 percent for 401(k) participants in the lowest-income group.

5 percent to 12 percent
for participants in the highest-income group.

The report, written by Jack VanDerhei , a faculty member at Temple University's Fox School of Business and Management and an EBRI Fellow, used data from the 2007 Retirement Confidence Survey (RCS) to indicate how high workers are likely to allow their default 401(k) contributions to go in plans with an automatic escalation feature, as revealed in the box below.

When the survey asked:

"Suppose your employer automatically increased the percentage of your salary contributed to the plan by 1 percent each time you received a raise. You could choose to discontinue the automatic increase at any time. At about what percentage of your salary do you think you would discontinue the automatic increase?"

    Discontinue the automatic increase immediately or before the first raise (indicated by 3 percent of employees).

    Discontinue the automatic increase when the contribution level hits between 1 to 5 percent of salary (indicated by 25 percent of employees).

    Discontinue the automatic increase when the contribution level hits between 6 to 10 percent of salary (indicated by 44 percent of employees).

    Discontinue the automatic increase when the contribution level hits between 11 to 15 percent of salary (indicated by 13 percent of employees).

    Would allow the increase to exceed 15 percent of salary (indicated by 14 percent of employees).

The Pension Protection Act (PPA), passed in 2006, allows employers to enroll workers in their 401(k) plan automatically and to increase a workers 401(k) contribution automatically to coincide with a raise or a work anniversaryalthough employees can decline enrollment and the increase. To qualify for nondiscrimination protections , automatic (or default) contributions must be at least 3 percent in the first year and must increase regularly. The provision was added in an attempt to boost 401(k) accounts, the primary vehicle for worker retirement savings.

"The Pension Protection Act is expected to have a significant impact on the plan design process," according to VanDerhei. However, he cautions, "It will be several years until researchers know how 401(k) participants react to automatic escalation of contributions in general, and the plan design of 401(k) plans as a result of PPA in particular."

Stephen Miller is manager of SHRM Online's Compensation & Benefits Focus Area.

Related Articles:

Resistance to 401(k) Auto Enroll: Sponsors' Fear of Added Costs Is Misguided, SHRM Online Comp & Benefits Focus Area, August 2007

401(k) Auto Enroll, Higher Matches Yield Employer ROI, SHRM Online Comp & Benefits Focus Area, July 2007

Automatic 401(k) Features Raise Participation, Savings, SHRM Online Comp & Benefits Focus Area, July 2007

Clearing the Annual 401(k) Compliance Test Hurdle, SHRM Online Comp & Benefits Focus Area, March 2007

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