Welcome back to my series based on my book “Save America, Save!” Today I’m covering the third automatic feature in “Auto to the 5th Power,” automatic escalation. This is my all-time favorite automatic feature, and here’s why.
I want to mention that I think this is the most important feature plan participants. In my first book, “Paychecks for Life,” I talk about a very simple mantra called “ten one now.” What does this mean?
On average, a plan participant needs to save 10% of their pay if they are going to have a chance at getting to their retirement years with enough money to pay for all the things they desire to do. Quite frankly, when I stand in front of plan participants and tell them to do this, a majority of them are going to say, “Charlie, that’s just not going to happen.”
However, they don’t realize is that there is more than one way to save that money. To illustrate that, I like to use an example of three different hypothetical plan participants: Susan, George, and Morgan. Let’s assume that each of them is 30 years old, make $40,000 per year, and want to save 10% each year.
Susan says she will save 10% of her pay over the next 35 years. After that period, she has over $445,000 in her account. That’s a tidy sum.
George tells me there is no way he can save 10% of his pay, but he can save 5%. I tell him to start with saving the 5% and then increase it by 1% each year until it gets to 10%. This gives him five years to get things going, and he will wind up with about $405,000 in his account by the time he is 65. That’s almost as much as Susan saved.
Morgan is in a similar position to George. However, instead of increasing her contributions by 1% each year, she keeps it at 5% until she is 65. At that point, Morgan will have only saved $225,000. I call that the $200,000 mistake. By not increasing those contributions, she loses out on $200,000 of compound interest on her investment.
Left to their own devices, most plan participants will never increase their contribution. It’s a habit that plan participants are generally poor at forming, just like dieting and regular exercise. However, the more plan participants save, the more they’ll get out of it and the more they get at retirement.
How can you help plan participants out in this area? Let’s go back to the subject of this article: automatic escalation. It’s a really simple process. Every year on January 1, the plan sponsor will send a notice to all the plan participants letting them know that their contribution will be increased by just 1%. If plan participants don’t want it increased, all they have to do is notify the plan sponsor or their HR Department. However, statistics show that over 80% of participants, when sent a notice that their contribution will be increased, allow it to be increased. This is how plan participants can incrementally save more each year until they get to that 10% savings mark. Then they all can live by my “ten one now” mantra.
Next time, I’ll cover automatic re-enrollment, a very powerful tool and interesting topic. If you have any questions for me in the meantime, don’t hesitate to reach out and give me a call or send me an email. I look forward to hearing from you.