Beyond Auto-Enrollment: Auto-Escalation and Stretched Match

The first in a series of articles about how to boost retirement plan participant engagement and outcomes beyond automatically enrolling employees.

Plan sponsors that have adopted automatic enrollment may, indeed, like the numbers they see. To give just two examples from PLANSPONSOR’s 2015 Plan Sponsors of the Year, JE Dunn construction company’s 401(k) plan participation rate increased from 77% to 91.94% after auto-enrolling and re-enrolling its workers, and Gillette Children’s Specialty Healthcare’s 403(b) plan participation rate increased from 82% to 96%. But, as those sponsors may agree, it takes much more to create a winning plan.                       

Joe Ready, director of institutional retirement and trust for Wells Fargo Retirement in Charlotte, North Carolina, is emphatic: “The only way people will have a good retirement outcome is to save their way there.” Utilizing automatic deferral escalation and stretched matching formulas are “the next evolution of how we can help on their savings behavior,” he says. And while many plan sponsors take a tentative approach, auto-enrolling employees at 3% and letting them idle there, Ready advises moving them to 10% as soon as possible—auto-enrolling at 6%, then auto-escalating their deferrals 1% per year to a maximum of 10%.

“There really isn’t a discernible difference between defaulting at 3% or 6%,” he says, citing Wells Fargo data. “The opt-out rates are really very similar—around 15%.”

Plan sponsors may auto-increase deferrals as much as 10%, as established by the Pension Protection Act of 2006 (PPA). The industry has been urging Congress to raise the maximum to 15%, he says.

NEXT: Who started the inertia?

If sponsors fear pushback, they need only to realize they may have caused the inertia themselves. “They could be inadvertently sending the message that 3% is sufficient,” says Pat Murphy, president of John Hancock Retirement Plan Services. “People think, ‘If my company put me at 3%, it must know what it’s doing—that must be the good number, so I’ll stay there.’”

Sponsors also may hedge at the perceived greater cost—the match feature is always a consideration when deciding whether to bump up deferrals, Ready says.

“That’s where you get into the idea of a stretched match,” notes Murphy. Referring to it as “the next phase of ‘auto’—‘auto-escalation 2.0,’” he says, “Here you keep the expense of running the 401(k) plan the same for the corporation but encourage participants to contribute at higher amounts to get that full match.” With a stretched match in place, participants voluntarily increase their contributions, removing any onus the sponsor may feel in doing it for them.

To cite a simple—and common—example of a stretched match formula: A plan sponsor that currently matches a participant’s deferral dollar for dollar up to 3% of salary will spend no more by matching 50 cents on the dollar up to 6% of salary. JE Dunn, in fact, uses this model, auto-enrolling participants at 6% to start.

At the same time, both Ready and Murphy agree, this effort lets employees know that the company wants them to aim for a higher savings rate.

NEXT: The best plan for a stretched match?

Employers can start by fully understanding the meaning of retirement readiness—specifically in terms of its unique employee base—and balancing their match formula accordingly, Ready says.

This requires data analysis. Through consulting with their plan adviser, sponsors can first look at plan demographics such as age, gender, compensation rate, even ethnicity, he says, then at the current average savings rate to pinpoint where a change would most help. “Where are people stuck, and how do I revise my formula when I look at that detail and get them to optimize to a higher level? If the average savings rate is at 5% and you want to get them to 10%, maybe you can stretch the formula to match a rate of 6% or 8%. You can keep tweaking that formula,” he says.                             

At the same time, though, the match can be stretched to the point where employee engagement snaps. “You do need to be careful,” Ready says. “You don’t want to stretch it so far that you have just a select group getting to the maximum of the stretched formula and you’ve demotivated other people: ‘It’s such a stretch, the money’s not that enticing because I can’t get all the way to 10%.’”

While hitting that balance demands self-study, some plans may discover that, for them, the enhancements are not worth pursuing. Murphy notes that John Hancock tells its clients what the features can do and how they may—or may not—be able to help. “[We ask] are they trying to attract and retain employees? Maybe they just want to replace 50% of someone’s income. Maybe they have a rich pension plan, so the [defined contribution plan] should be looked at in overall context of their retirement and benefits programs.” 

NEXT: Implementation considerations.

The use of stretched matches is still fairly uncommon, Murphy notes. He says they particularly meet the need of companies that want to help their participants save but, due to budgetary constraints, must limit their investment. No long-range predictions have been made as to how they may affect retirement readiness. He does note that early reports show plans with stretched matches, “do tend to have higher participation rates and deferral rates.”

When a plan sponsor does decide to auto-escalate and/or revise its match formula, announcing the change to participants and the way in which it is done is important. “When implementing these features, [the sponsor] needs to analyze how to make it as easy as possible on the participants,” Murphy says. “For example, make easy messaging a part of the implementation; use education and communications—why [the feature] is important and how to best utilize it; have face-to-face meetings, send emails, use mobile apps, have multiple communication channels.”

To further stress the point, Ready says, the deferral increase can be tied to the annual salary increase. “It makes those things go hand and hand and is usually pretty well-received by the employee base: ‘I see what you’re doing.’ It creates a win-win in the process.”

From there, sponsors may be able to depend on momentum. Murphy says he has seen the difference when participants catch on to the concept of growth. “We tend to get more engagement from participants [at 6% rather than at 3%] once they start to see the money accumulating in their account,” he says. “It’s all theoretical until then.”