The benefits of automatic escalation in 401(k) plans

7 MIN READEditorial Policy

Key Takeaways

  • We believe that plan design features like automatic escalation (auto-escalation) are among the most effective ways to encourage employees to save for retirement.

  • Auto-escalation automatically increases an employee’s deferral rates to their retirement savings at set intervals until it hits the maximum contribution rate.

  • Auto-escalation may encourage less financially proactive employees to save more for retirement.

A 401(k) plan can be customized with different provisions and features to help drive and incentivize employees to save for retirement. These features include automatic enrollment, employer matching contributions, vesting schedules, and more. Automatic escalation, or auto-escalation, is one such feature that can effectively drive participant savings, especially when combined with automatic enrollment. 

Below, we’ll dive deeper into how automatic escalation works and its advantages. This article will also cover how using it in conjunction with automatic enrollment can boost employee savings. 

What is automatic escalation?

To understand auto-escalation, it’s important to first understand automatic enrollment (or auto-enroll). In an auto-enroll plan setup, all newly eligible employees automatically have a default percentage of their compensation contributed to their plan each paycheck. Employers set the default elections in their plan document, but employees may choose to opt out of their plan at any time.

Employers are also responsible for setting the default contribution rates in auto-enroll plans. According to the Plan Sponsor Council of America’s 64th Annual Survey of Profit Sharing and 401(k) Plans, the most common default deferral rate was 6%¹. But to boost savings rates among employees, Human Interest recommends plans should have at least a 7% default deferral rate.  

Automatic escalation is designed to periodically increase an employee’s contribution rate to their 401(k) plan. For example, if an employer sets the automatic escalation rate at 1% a year, every year an employee’s contribution rate will increase by 1%. 

Default Contribution Rate (Year 1)Year 2Year 3Year 4

An example of a 1% automatic escalation over three years.

Auto-enrollment and auto-escalation may help drive savings

One of the motives of automatic escalation is to combat contribution stasis. Contribution stasis occurs when participants' contribution rate remains the same after many years, even as their income increases, which can prevent them from maximizing their retirement savings. 

One of the reasons why automatic features, such as automatic enrollment, may be effective is because they benefit from behavioral biases such as behavioral inertia and social proof. Behavioral inertia occurs when it takes more effort and energy to perform an action than it does to leave something in its default state. Features like auto-enrollment and auto-escalation help reduce cognitive load so that savers stay enrolled in a retirement savings plan, at a default contribution rate. Social proof is when others yield to social norms and behaviors. In fact, a Human Interest study from 2022 found that 81% of savers would either enroll in a plan or increase contributions if they learned that most of their coworkers were already enrolled.

SECURE Act 2.0 automatic escalation requirements 

The SECURE Act was signed in 2019 and has since received an additional package known as SECURE 2.0. SECURE 2.0 added over 90 retirement plan provisions to help reduce the retirement savings gap by adding incentives for small businesses to offer retirement plans, increasing contribution limits, and giving older adults more flexibility to save as they get closer to retirement. 

One of the most significant changes of SECURE Act 2.0 was the requirement for new plans to offer auto-enroll if they’re started after December 29, 2022, beginning with the 2025 plan year. This legislation requires that automatic contributions must be at least 3% and may be up to 10% of employee compensation and include an annual auto-escalation of 1% until at least 10% is reached, but no more than 15%. 

Are you ready for SECURE Act 2.0?

Watch our on-demand webinar to learn what SECURE 2.0 means for your business and your employees.

Can automatic escalation increase 401(k) plan participation? 

Auto-escalation may directly lead to higher savings rates because it allows employers to incrementally increase their employees’ deferral rates over time. Additionally, a study from Vanguard found that retirement plans administered on their platform with an auto-enroll provision had a participation rate that was three times higher than plans with voluntary enrollment. 

A 2021 study evaluated how employer contributions and default rates influenced the savings outcomes of new employees. The study concluded that default deferral rates might impact how much an employee saves, perhaps even more so than an employer match. When plans have high deferral savings rates, it results in higher, more equitable savings rates because employees are less likely to change their deferral rates due to behavioral biases.

With these factors in mind, it’s our recommendation that employers should generally use automatic enrollment and auto-escalation together, along with a higher default savings rate and high employer match, so that all employees—regardless of income—are empowered to save more for retirement.

Advantages of automatic enrollment and automatic escalation

Together, automatic enrollment and automatic escalation can help employees save more money and drive contribution participation. But there are also other advantages that come with these two features. For plan sponsors who offer the two plan design features, auto-enrollment and auto-escalation can:

  • Attract and retain employees: Auto-enrollment and auto-escalation may help simplify the retirement enrollment process, thereby making it easier to keep employees who want easy-to-manage retirement benefits.  

  • Lighten administrative and compliance burdens: Automatic features can aid in passing nondiscrimination testing requirements and reduce the manual work to onboard a new employee. 

  • Help businesses earn tax credits and deductions: According to the SECURE Act 2.0, a business can earn a tax credit of $500 per year for the first three years of electing auto-enrollment.  

Consider adding automatic escalation to your 401(k) plan 

Automatic escalation is a powerful provision that may help employees across all income levels participate in their retirement plans. But automatic enrollment alone may not be enough to help employees reach their retirement goals, which is why we suggest combining automatic escalation and automatic enrollment with higher default contribution rates to make it easier for employees and employers to reduce saving indecision. 

If you’re interested in learning more about what automatic escalation can do for your business, contact our team.

We believe that everyone deserves access to a secure financial future, which is why we make it easy to provide a 401(k) to your employees. Human Interest offers a low-cost 401(k) with automated administration, built-in investment education, and integration with leading payroll providers.

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PSCA’s 64th Annual Survey of 401k and Profit Sharing Plans reports on the 2020 plan-year experience of 518 plans. This survey was published on December 15, 2021.