Industry observers generally do not see drawbacks to setting higher caps on auto escalation given that participants can opt out of the default deferral rate.

“What we found in general in our research and our data is that people tend to stick with auto escalation and with auto enrollment, but they’ll do the right thing for themselves,” Voya’s Mr. Armstrong said. “They can opt out of these programs at any point and self-navigate the waters of the optimal savings rates for themselves.”

Catherine Collinson, CEO and president of non-profit Transamerica Institute and Transamerica Center for Retirement Studies in Los Angeles, does envision a scenario where a high auto-escalation cap could backfire.

As she sees it, employers not offering annual pay increases could face an employee relations risk.

If employees are not getting a raise and they’re auto-escalated each year, “they’re going to feel it in their paycheck and it could be painful,” she said. “If an employer’s financial situation is such that there are either pay freezes or potential cuts, it’s not a good time to implement an extreme auto escalation,” she said, referring to aggressive caps of more than 15%.

Aggressive caps, however, can be appropriate, especially in organizations with low turnover, according to Voya’s Mr. Armstrong. “If they have higher-tenured employees or employees who they believe will stick with them for longer periods of time, those caps likely then become more real and more impactful,” he said. “At higher turnover, lower-tenured organizations, they can set the cap higher, but it’s likely that many of those people will never hit the cap, especially if they increase 1% per year.”

Alicia Munnell, director of the Center for Retirement Research at Boston College, nevertheless has reservations about aggressive auto-escalation caps, particularly those set at 25% or more, and generally would not recommend them for plan sponsors.

The goal of saving is to smooth consumption over an individual’s lifetime so that the individual can maintain the same level of consumption both before and after retirement, she said.

“These really high savings rates only make sense for people who are going to retire very early. If people are going to retire at the full retirement age, which is 67, those rates seem higher than is necessary,” she said, referring to savings rates of 25% or more. “You’re going to be having too much money in retirement and too little money when you’re working.”

“You want to set the auto-escalation limit as something that would be useful for the majority of your employees, and it’s unlikely that the majority would be retiring in their 50s,” she said.

Source: https://www.pionline.com/defined-contribution/sponsors-take-closer-look-lifting-auto-escalation-caps