In a bid to boost retirement savings, plan sponsors are getting bolder with their auto-escalation caps.
More and more sponsors are upping the maximums to which they can automatically escalate participant deferral rates beyond the typical 10% of employee pay.
In 2020, 26% of plan sponsors had auto-escalation caps of more than 10%, up from 19.9% that had such caps in place in 2019, according the Plan Sponsor Council of America's upcoming annual survey of profit-sharing and 401(k) plans expected to be released mid-December.
Some plan sponsors are going even higher, with 5.2% setting maximums greater than 15%.
Nestle USA Inc., for instance, automatically enrolls participants in its $7.3 billion 401(k) plan at an initial 6% savings rate and then auto-escalates them annually up to a maximum of 25% of employee pay, the company's Solon, Ohio-based savings plan administrator Annie Diaz said during Pensions & Investments Defined Contribution West conference in San Diego in October.
Ms. Diaz declined to provide additional details of the new auto-escalation provisions, saying that they were only recently implemented.
"We have been both talking to sponsors and seeing some sponsors increasing their auto-escalation caps," said Tom Armstrong, vice president of customer analytics and insights at Voya Financial in Braintree, Mass.
Mr. Armstrong says that while the greatest interest is in increasing the cap above 10%, some plan sponsors have considered implementing caps greater than 15% with a handful actually putting them in place.
"It really has been a small number of plans that have implemented above the 15% but we are starting to see more sponsors think about going up to 15%," he said.
As sponsors look to lift employee savings rates, they're increasingly re-examining their auto-escalation caps and other automatic design features of their plans, according to industry observers. While there are no set guidelines as to how much participants should save, record keepers and other retirement experts generally recommend employee savings rates — including the employer match — ranging from 10% to 20% of employee salaries.
Jamie McAllister, senior vice president and defined contribution consultant at Callan LLC in Chicago, said that the firm is seeing "a greater movement" among plan sponsors to "make the escalation cap higher" as they focus on helping participants hit their retirement goals.
"They're seeing that this is one of the ways to do it," she said, referring to the challenge of getting participants to save more.
The trend toward higher caps comes in the wake of the SECURE Act, which raised the auto-escalation cap for safe-harbor plans to 15% from 10%. Non-safe-harbor plans can go higher than 15% because they don't have any cap restrictions.
"The SECURE Act itself is probably one reason that sponsors are considering increasing the cap," Voya's Mr. Armstrong said.
Another reason driving the uptick in auto-escalation caps is that sponsors recognize that an ultimate 10% employee savings rate — the most common cap favored by plan sponsors — might be OK for younger workers but not for middle-aged or older workers who haven't saved enough or in some instances have cashed out their retirement accounts, Mr. Armstrong added.
"I think the notion is that we can help them catch back up and get back on track faster," he said.
Research, too, has consistently highlighted the merits of auto-escalation features, a factor that has helped sway sponsors to raise their caps. In a recent study of 350 plans from 2015 to 2020, Vanguard Group Inc., for example, found that where annual increases are automatic, participants tend to let them ride. In Vanguard's study, 8 in 10 participants had the automatic increases in place even after five years.
"A higher automatic-escalation cap can help participants achieve a higher savings rate," said Brian Alling, the Malvern, Pa.-based head of advanced analytics for Vanguard strategic retirement consulting, adding that Vanguard generally recommends that participants save between 12% to 15% or more of their salary, inclusive of an employer match.
"Since the median employer match is about 4%, plan sponsors may need to cap auto-escalations above 10% to help their participants achieve a healthy savings rate," he said.
How quickly participants reach the peak savings rate depends on the size of the automatic annual increase. The overwhelming majority of plan sponsors today — 85% — auto-escalate participants by 1 percentage point a year, according to the PSCA's upcoming survey.
For Voya, the standard annual increase, along with the traditional cap of 10%, could go higher. The record keeper recommends that plan sponsors consider increasing their caps up to 15% and couple that with automatic annual increases of 2% of salary instead of the industry standard of 1%. In addition, it recommends that they consider increasing their auto-enrollment default deferral rates.
Of course, there's only so much higher caps can do to raise retirement savings as participants are limited in how much they contribute to their retirement plans annually. The individual contribution IRS limit for both 401(k) and 403(b) plans is currently $19,500 and will rise to $20,500 in 2022.
Industry observers generally do not see drawbacks to setting higher caps on auto escalation given that participants can opt out of the default deferral rate.
"What we found in general in our research and our data is that people tend to stick with auto escalation and with auto enrollment, but they'll do the right thing for themselves," Voya's Mr. Armstrong said. "They can opt out of these programs at any point and self-navigate the waters of the optimal savings rates for themselves."
Catherine Collinson, CEO and president of non-profit Transamerica Institute and Transamerica Center for Retirement Studies in Los Angeles, does envision a scenario where a high auto-escalation cap could backfire.
As she sees it, employers not offering annual pay increases could face an employee relations risk.
If employees are not getting a raise and they're auto-escalated each year, "they're going to feel it in their paycheck and it could be painful," she said. "If an employer's financial situation is such that there are either pay freezes or potential cuts, it's not a good time to implement an extreme auto escalation," she said, referring to aggressive caps of more than 15%.
Aggressive caps, however, can be appropriate, especially in organizations with low turnover, according to Voya's Mr. Armstrong. "If they have higher-tenured employees or employees who they believe will stick with them for longer periods of time, those caps likely then become more real and more impactful," he said. "At higher turnover, lower-tenured organizations, they can set the cap higher, but it's likely that many of those people will never hit the cap, especially if they increase 1% per year."
Alicia Munnell, director of the Center for Retirement Research at Boston College, nevertheless has reservations about aggressive auto-escalation caps, particularly those set at 25% or more, and generally would not recommend them for plan sponsors.
The goal of saving is to smooth consumption over an individual's lifetime so that the individual can maintain the same level of consumption both before and after retirement, she said.
"These really high savings rates only make sense for people who are going to retire very early. If people are going to retire at the full retirement age, which is 67, those rates seem higher than is necessary," she said, referring to savings rates of 25% or more. "You're going to be having too much money in retirement and too little money when you're working."
"You want to set the auto-escalation limit as something that would be useful for the majority of your employees, and it's unlikely that the majority would be retiring in their 50s," she said.
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