Your 401(k): When It Was Invented—and Why
We tend to think of 401(k) plans as the bedrock of the retirement savings system.
But these plans, named after a section in the Internal Revenue Code, were actually developed more by accident than by design. When lawmakers originally established the Revenue Act of 1978, the goal was to limit executives at some companies from having too much access to the perks of cash-deferred plans. (Why, you ask? Since the 1950s, companies had been fighting with the Internal Revenue Service to allow more money to be squirreled away in such plans.)
The accidental birth of the 401(k) can be credited to Ted Benna. In 1980, the benefits consultant used his interpretation of the law to create a 401(k) plan for his own employer, The Johnson Cos., that allowed full-time employees to fund accounts with pre-tax dollars and matching employer contributions. Benna then asked the Internal Revenue Service to change some proposed rules under the law that ultimately lead to the widespread adoption of 401(k) plans by employers in the early 1980s.
“I knew it was going to be big, but I was certainly not anticipating that it would be the primary way people would be accumulating money for retirement 30 plus years later,” Benna, now semi-retired and the president of the 401(k) Association, told Workforce magazine.
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The 401(k) Grows Up: A 30-Year Timeline
In the early 1980s, 401(k) plans were only available at a handful of large companies, such as Johnson & Johnson. Today, some 94% of private employers offer them. That’s incredible progress!
A 401(k) plan is a retirement account that you can only access through an employer. You contribute a portion of your salary to the plan, and if you choose to put that contribution in a traditional 401(k), it isn’t taxed until you withdraw the money, allowing your investments to grow over time without being taxed. (Note: You will pay penalties if you take out the money before a set retirement age, as defined by the plan.) And, as an added bonus, many employers will match some of your contributions.
In its relatively short history—just 30 years!—401(k) plans have had many milestones:
1978: Congress passes the Revenue Act of 1978, which includes a provision that allows employees to avoid being taxed on a portion of income that they decide to receive as deferred compensation, rather than direct pay. The provision becomes Internal Revenue Code Sec. 401(k).
1981: The I.R.S. issues rules allowing the funding of 401(k) plans through employee salary reductions.
1982: Several companies—such as Johnson & Johnson, PepsiCo and Honeywell—begin to offer 401(k) plans to their employees. By 1983, nearly half of all large employers either offer a 401(k) plan or are considering offering one, according to the Employee Benefit Research Institute.
1984: The Tax Reform Act of 1984 requires “nondiscrimination” testing to prevent 401(k) plans from favoring highly compensated employees over rank-and-file workers. At the time, Congress was concerned that executives would take advantage of 401(k) plans more than lower-paid employees.
1996: Assets in 401(k) plans surpass $1 trillion, with more than 30 million participants.
2001: The Economic Growth and Tax Relief Reconciliation Act of 2001 provides for catch-up contributions for participants 50 and older (as of 2013, the max catch-up contribution is $5,500), as well as the creation of Roth 401(k)s, which let after-tax contributions grow tax-free.
2006: The Pension Protection Act of 2006 allows employers to automatically enroll employees in 401(k) plans, and offer target-date funds as a default option.
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