Your Employer’s Automatic 401(k) Enrollment: 3% Won’t Cut It
Don’t settle for the default rate – take control and max out your retirement savings
Many employers give workers a well-intentioned nudge to get rolling on saving for retirement. New employees are often automatically enrolled in the 401(k); anyone who doesn’t want to participate must actively opt out.
That nice feature has helped boost the percentage of workers who contribute to a 401(k) or other workplace retirement plan. But there’s a serious flaw. When a plan automatically enrolls a worker, the plan chooses a contribution rate – percentage of salary – to set for the worker. This is commonly known as the default contribution rate. And this is where your employer can undermine your future retirement security.
Many plans set an initial default contribution rate of 3%. That is way, way too low. If you start saving for retirement in your 20s, experts recommend you save at least 10% of your salary. If you’ve waited until your 30s to get serious, your target should be 15%.
Even if your employer kicks in a matching contribution, that’s still going to leave you way short of those target levels if your own initial contribution rate is just 3%.
What your savings earn is, of course, important, but the key driver to your retirement success is going to be how much you manage to save. Steady investment of a meaningful percentage of income is the secret sauce to retirement saving.
The best path is to start out with a high percentage of savings, say 10% or 15% of your income, and maintain that as your income grows. Any employer matches will further beef up your retirement security. If you can’t save that percentage right away, a gradual plan can work, too.
Ratcheting up your savings rate
If you were automatically enrolled in a plan, you may also be signed up for “automatic escalation.” This is a feature that increases your contribution rate every year, or when you get a raise. The typical boost is 1 percentage point.
That’s another well-intentioned feature, but if you start at 3%, it’s going to take years to get to 10%. And if you job hop and aren’t paying attention, your contribution rate may roll back to 3% if you’re automatically enrolled in your new employer’s plan.
To get to 10% to 15% ASAP, commit to an annual increase of at least 2 percentage points. What’s more, whenever you get a raise, direct most of it to further boost your retirement savings rate. For instance, if you get a 4% raise, increase your retirement savings rate by 3 or 4 percentage points. That’s new money, that you haven’t yet grown accustomed to, showing up in your checking account, so you can’t rationalize that you can’t afford to boost your savings rate.