Your 401(k): When It Was Invented—and Why

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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.

RELATED: IRA vs. 401(k): Which Is Better?

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.

RELATED: The Roth 401(k): What Is It—and Should You Sign Up?

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.

RELATED: 5 Steps to Simplifying Your 401(k)

  • Dianne Juhl

    401Ks and IRAs are broken, volatile, and expensive — exactly because of its accidental design. Both were understood by the corporate executives and their advisors to be a supplement to the executives’ pension and retirement plans, not the primary source of retirement funds itself. What you don’t say is that this design and the legislation supporting it actually opened the door to corporate cost cutters who axed pensions and ‘disappear’ the facts to employees about what 401Ks and IRAs are designed to do and how they behave. Of course, relatively few financial investment advisors will look at your Also no one can afford to forget that it is YOUR retirement funds, but THEIR money. Employers and especially the fee-earning financial professionals managing the employee’s investment choices and the underlying mutual funds, stocks, etc.

  • Dianne Juhl

    The 401(k) is a broken ‘invention’, uncontrollably volatile in its performance, and exorbitantly expensive to use. Not desirable, usable, or useful.

    Since its ‘accidental invention’ (not) and the demise of pensions, employee-based savings plans have evolved in 30 in years’ time, or shall I say regressed, into a money train for the financial services professionals and 401(k) record keepers who count workers’ savings toward their assets under management and collect the fees. This doesn’t seem like “incredible progress” as Tom Anderson proclaims in this article.

    It may be YOUR retirement fund as an employee, but it is THEIR money. Extravagantly high 401(k) fees and expenses significantly reduce employee returns after compounding, and reduce a person’s account balance at retirement by an average of three years’ worth of salary. For employees who work hard for the money, that is a high price to pay for a lifetime of savings management.

    What employees need to understand about the 401(k) is not history, but the truth about these employee-based savings plans. The gaps and silences in Tom Anderson’s narrative of 401(k) history are actually shouting. This narrative begs us to question the dark side of the 401(k) system, who actually benefits from this system, and whether the 401(k) is really a corporate “perk” or an oxymoron.

    Which brings me to this question: When did we ever think it is ok for financial services companies who manage employee-based savings plans to extravagantly profit from the 401(k) system’s ‘accidental’ invention, from corporations’ complacency, and from employees’ lack of true information, or misinformation by those who make a living investing and managing nest eggs on behalf of workers.

    Tell me, how did we arrive at this point?

    Abundant regards,

    ∞ Dianne Juhl

    Founder & CEO, The Feminine Face of Money
    email: dianne@femininefaceofmoney.com
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  • Boothie

    I found this article interesting. However, I don’t know of many people who can afford to put the maximum in. If you can, then that’s great. But, there really is too many other priorities (house, kids, living, etc). Most people struggle just to be able to max out the matching that is sometimes supplied by the employer.