Be Careful With Auto Escalation Rates, Says Study

Virtually any action, even one that is beneficial and well-intentioned, can have unintended consequences. And adopting auto-escalation is one such area, says an investment management corporation.

In “Best Intentions: The Unintended Consequences of Plan Design,” BlackRock posits that “The most well-intentioned and carefully considered plan design decisions may have unexpected results and even successful implementations occasionally reveal the limits of some baseline assumptions.” One of the case studies they use to illustrate the point concerns adopting auto-escalation and setting the deferral rate.

BlackRock studied a large employer with more than 100,000 plan participants and $5 billion in assets that added auto-escalation for new participants. Contributions increase by 1% every year to a maximum of 6%. The plan set that maximum out of concern that if the cap was too high, a large number of participants would opt out.

Passive participants — those not actively involved in running their accounts — had average deferral rate of 4.9%, BlackRock found. The active participants had an average rate of 6.8%, but less than half — 43% — were interested in a deferral rate well above the 6% maximum the plan set.

The cap the plan set may actually be limiting saving through the plan, BlackRock concluded. “The unintended effect that setting defaults and auto-escalations too low may have is to undermine the power of these plan design features and ironically prevent some participants from saving more,” it says.