What Is 401(k) Auto Escalation?
One way to ensure you’re steadily working toward your retirement goals is to automate as much of the process as possible. Some employers streamline the retirement savings process for their employees with automatic enrollment, signing you up for a retirement plan unless you choose to opt out.
There are many ways to automate a 401(k) experience at every step of the way. You can have contributions taken directly from your paycheck before they ever hit your bank account and invest them right away. With automatic deductions, you’re more likely to save for your future rather than spending on immediate needs.
In some cases, you may also be able to automatically increase the amount you save. Some employers also offer a 401(k) auto escalation option that could increase your retirement savings amount as you get older. Here’s a closer look at how 401(k) auto escalation works and how it may help you on your way to your retirement goals.
Key Points
• 401(k) auto escalation automatically increases contributions at regular intervals until a preset maximum is reached.
• The SECURE Act allows auto escalation up to 15% of an employee’s salary.
• Auto escalation helps employees save more for retirement without needing to adjust contributions manually.
• Employers benefit from auto escalation by attracting and retaining talent and possibly reducing payroll taxes.
• Employees should assess if auto escalation aligns with their financial capabilities and retirement goals.
401(k) Recap
A 401(k) is a defined contribution plan offered through your employer. It allows employees to contribute some of their wages directly from their paycheck. Contributions are made with pre-tax money, which may reduce taxable income in the year they are made, providing an immediate tax benefit.
In 2024, employees can contribute up to $23,000 a year to their 401(k), up from $22,500 in 2023. Those aged 50 and older can contribute an extra $7,500, bringing their potential contribution total to $30,500 in 2024 and $30,000 in 2023.
For many individuals, the goal is to eventually max out a 401(k) up to the contribution limit. Employers may offer matching funds to help encourage employees to save. Individuals should aim to contribute at least enough to meet their employer’s match, in order to get that “free money” from their employer to invest in their future.
💡 Quick Tip: Did you know that you must choose the investments in your IRA? Once you open an IRA account and start saving, you get to decide which mutual funds, ETFs, or other investments you want — it’s totally up to you.
How 401(k) Auto Escalation Works
An auto escalation is a 401(k) feature that automatically increases your contribution at regular intervals by a set amount until a preset maximum is achieved. The SECURE Act, signed into law in 2019, allows auto escalation programs to raise contributions up to 15%. Before then, the cap on default contributions was 10% for auto escalation programs.
For example, you may choose to set your auto escalation rate to raise your contributions by 1% each year. Once you hit that 15% ceiling, auto escalation will cease. However, you can still choose to increase the amount you are saving on your own beyond that point.
Recommended: Understanding the Different Types of Retirement Plans
Advantages of 401(k) Auto Escalation
When it comes to auto escalation programs, there are important factors to consider — for employees as well as for employers who sponsor the 401(k) plan.
Advantages for Employees
• Auto escalation is one more way to automate savings for retirement, so that it is always prioritized.
• Auto escalation may increase the amount employees save for retirement more than they would on their own.
• Employees don’t have to remember to make or increase contributions themselves until they reach the auto escalation cap.
• Increasing tax-deferred contributions may help reduce an employee’s tax burden.
Advantages for Sponsors
Employers who offer auto escalation may find it helps with both employee quality and retention as well as with reducing taxes.
• Auto escalation provides a benefit that may help attract top talent.
• It helps put employees on track to automatically save, which may increase retention and contribute to their sense of financial well-being.
• It reduces employer payroll taxes, because escalated funds are contributed pre-tax by employees.
• It may generate tax credits or deductions for employers. For example, matching contributions may be tax deductible.
• As assets under management increase, 401(k) companies may offer lower administration fees or even the ability to offer additional services to participants.
Disadvantages of 401(k) Auto Escalation
While there are undoubtedly benefits to 401(k) auto escalation, there are also some potential downsides to consider.
Disadvantages for Employees
Even on autopilot, it can be important to review contributions so as to avoid these disadvantages.
• Auto escalation may lull employees into a false sense of security. Even if they’re increasing their savings each year, if their default rate was too low to begin with, they may not be saving enough to meet their retirement goals.
• If an employee experiences a pay freeze or hasn’t received a raise in a number of years, auto escalation will mean 401(k) contributions represent an increasingly larger proportion of take-home pay.
Disadvantages for Sponsors
Employers may want to consider these potential downsides before offering 401(k) auto escalation.
• Auto escalation requires proper administrative oversight to ensure that each employee’s escalation amounts are correct — and it may be time-consuming and costly to fix mistakes.
• This option may increase the need to communicate with 401(k) record keepers.
• Auto escalation may cause employer contribution amounts to rise.
💡 Quick Tip: Did you know that opening a brokerage account typically doesn’t come with any setup costs? Often, the only requirement to open a brokerage account — aside from providing personal details — is making an initial deposit.
Is 401(k) Auto Escalation Right for You?
If your employer offers auto escalation, first determine your goals for retirement. Consider whether or not your current savings rate will help you achieve those goals and whether escalation could increase the likelihood that you will.
Also decide whether you can afford to increase your contributions. Perhaps your default rate is already set high enough that you are maxing out your retirement savings budget. In this case, auto escalation might land you in a financial bind.
However, if you have room in your budget, or you expect your income to grow each year, auto escalation may help ensure that your retirement savings continue to grow as well.
If your employer does not offer auto escalation, or you choose to opt out, consider using pay raises as an opportunity to change your 401(k) contributions yourself.
The Takeaway
A 401(k) is one of many tools available to help you save for retirement — and auto escalation can help you increase your contributions regularly without any additional thought or effort on your part.
If you’ve maxed out your 401(k) or you’re looking for a retirement account with more flexible options, you might want to consider a traditional or Roth IRA. Both types of IRA offer tax-advantaged retirement savings, and in 2024, individuals can contribute $7,000 per year across IRA accounts, with an extra $1,000 catch-up contribution available to those aged 50 and older. In 2023, individuals can contribute $6,500 per year across IRA accounts, with an extra $1,000 catch-up contribution available to those aged 50 and older.
Ready to invest for your retirement? It’s easy to get started when you open a traditional or Roth IRA with SoFi. SoFi doesn’t charge commissions, but other fees apply (full fee disclosure here).
FAQ
Is 401(k) auto enrollment legal?
Yes, automatic enrollment allows employers to automatically deduct 401(k) contributions from an employee’s paycheck unless they have expressly communicated that they wish to opt out of the retirement plan.
What is automatic deferral increase?
Automatic deferral increase is essentially the same as auto escalation. It automatically increases the amount that you are saving by a set amount at regular intervals.
Can a company move your 401(k) without your permission?
Your 401(k) can be moved without your permission by a former employer if the 401(k) has a balance of $5,000 or less.
Photo credit: iStock/Halfpoint
Third-Party Brand Mentions: No brands, products, or companies mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third-party trademarks referenced herein are property of their respective owners.
INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE
Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.
Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.
SoFi Invest®
1) Automated Investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser (“SoFi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC.
2) Active Investing and brokerage services are provided by SoFi Securities LLC, Member FINRA (www.finra.org)/SIPC(www.sipc.org). Clearing and custody of all securities are provided by APEX Clearing Corporation.
For additional disclosures related to the SoFi Invest platforms described above please visit SoFi.com/legal.
Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform.
SOIN0124073
Read more