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 up front that I think this is the most important feature you can add to your employees’ retirement plans. In my first book, “Paychecks for Life,” I talk about a very simple mantra called “ten one now.” What does this mean?
On average, an employee 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 your employees 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 employees: Susan, George, and Morgan. Let’s assume that each of them are 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 of time, she has over $445,000 in her account. That’s a tidy sum.
Now 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 in her account. 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, a majority of employees will never increase their contribution. It’s a habit that people are generally poor at forming, just like dieting and regular exercise. However, the more you do it, the more you get out of it. The more you save, the more you get in the end.
How can you help your employees 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 1st, you send out a notice to all your employees letting them know you’ll increase their contribution by just 1%. If they don’t want it increased, all they have to do is notify you or your 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 you can incrementally help your employees save more each year until they get to that 10% 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.