What That 1% Increase Can Do for Participants

February 26, 2014 (PLANSPONSOR.com) – For those plan sponsors who may be hesitant to add an automatic deferral escalation feature to their Employee Retirement Income Security Act (ERISA) defined contribution (DC) plans, here’s something to consider.

An analysis by Fidelity Investments shows that for a 25-year-old, a 1% deferral increase—about $33 per month for someone making $40,000—could result in an additional $200 to $330 per month in retirement income. For a 35-year-old making $60,000, that 1% increase—about $50 monthly—could result in an additional $180 to $270 in monthly retirement income.

Of course, the analysis makes certain assumptions about wage increases, rates of return and retirement plan leakage, but it is still a message with a big impact. “I think the data definitely shows that by making an automatic annual increase, plan sponsors will benefit many more participants,” Beth McHugh, vice president of Thought Leadership and Market Insights at Fidelity in Albuquerque, New Mexico, tells PLANSPONSOR.

McHugh also notes that Fidelity’s analysis of 21,200 Fidelity recordkept 401(k) plans, finds one-third of all participant deferral increases through December 31, 2013 can be attributed to use of its automatic increase program. Among individuals younger than 35, more than half the increases are attributable to the automatic increase program.

While McHugh doesn’t think DC plan sponsors are as timid as they used to be about automatic deferral increases offered as an opt-in feature for participants, they are more timid about marrying automatic enrollment with automatic increase and making it an opt-out feature. The analysis shows 76.9% of Fidelity plans offer automatic deferral increases, but only 11.6% offer it as a true automatic feature, making employees opt out if they do not want it.

“If you start automatic enrollment at a 3% deferral rate, you need automatic increases to get participants to that recommended 15%-of-income savings rate, McHugh says. She points out that Fidelity has found employees are not likely to opt out; the average opt-out rate is about 13.4%. “People are not likely to opt in, but they are also not likely to opt out. [Automatic deferral increases are] a great tool considering participant inertia.”

McHugh adds that education about auto deferral increases is also important. Plan sponsors like the analysis showing the outcome of a 1% increase. “It educates participants more about the power of savings and the power of compounding,” she says.