A Brief History of...The 401(k)

Not to be confused with Stephen Hawking’s seminal work “A Brief History of Time”, here you will find a short primer on the beloved workplace retirement savings plan, the 401(k). If you were born after 1980, you would think that these employer plans have been around forever, but in reality, the plan is a relatively new workplace perk.

What is a 401(k)

The name 401(k) comes from the IRS Code Section 401(k). The basic premise is that it allows employees to defer a portion of their income into a savings vehicle thereby reducing their taxable income in that particular year.

How It Started

Congress enacted Section 401(k) in November of 1978. Ted Benna, a benefits consultant known as the “father of the 401(k)", popularized the plan by establishing one at his own company shortly after the code went into effect. It quickly became popular as a way for highly compensated employees to defer taxes from bonuses, but the plans really caught fire when the IRS issued a ruling allowing contributions to 401(k) plans via salary deductions.

Companies really liked the new plans because it was cheaper to administer, and more predictable than the more complex pension funds that were the standard at the time. It also didn’t hurt that employee participants were loving the fact they could defer tax on their income at a time when the highest marginal income tax rate was 70%. The idea was that one could defer tax now at the higher rate during their working years, then pay a lower tax rate when they take distributions in retirement when they were no longer earning an income. This is what you call a win-win scenario.

However, at one point in the 1980s Congress considered killing the newly popular plans for fear that too many taxpayers would be deferring tax, thus reducing annual tax receipts to the federal government. Needless to say, the 401(k) survived and has had some serious staying power.

Employers and employees continued to utilize the plans to invest in the market, and the number of participants more than doubled from 1990 to 2000. Further, bull market runs of the 1980s and 1990s caused all of that invested deferred income to swell to levels that put savers in a great position for retirement.

How It’s Going

Since the turn of the century, the 401(k) has become the preeminent retirement savings vehicle for American workers. Pensions have continued to decline and have become a rarity in the employer benefits world.

In 2006, Congress authorized the Roth 401(k), which allows employees to save their elective deferrals into an after-tax portion of their 401(k). This further bolstered the value of these workplace plans and allowed for workers to pay tax now (instead of defer it) and allow their savings to grow tax-free until their tax-free distribution in retirement.

Today many employers automatically enroll their employees in the workplace savings plans and the overwhelming majority also offer some type of employer contribution as well. 401(k) plans now hold over $7.4 trillion in assets in more than 700,000 plans with more than 70 million participants.

Sources: https://en.wikipedia.org/wiki/401(k); https://en.wikipedia.org/wiki/Roth_401(k); https://www.cnbc.com/2017/01/04/a-brief-history-of-the-401k-which-changed-how-americans-retire.html; https://www.investopedia.com/ask/answers/100314/why-were-401k-plans-created.asp; https://www.ici.org/401k#:~:text=401(k)%20plans%20hold%20%247.4,of%20former%20employees%20and%20retirees