The 401(k) Turns 40: How a Minor Provision Created a Powerhouse Savings Plan

2018 happens to be a big year for the 401(k) plan, as it marks its 40th birthday! A lot has changed over the past four decades, not least of all the 401(k) plan, which has been revised and morphed to better serve its participants. Let’s take a look into the past to discover how the 401(k) plan came to be and why it’s the most widely used and well-known retirement savings plan in the United States.

An Overlooked Tax Provision Revolutionizes Retirement Saving

When Congress passed the Revenue Act of 1978, it included provision Section 401(k) — which didn’t get much attention at the time. The provision allowed employees to avoid taxation on a portion of their income if they elected to receive it as deferred income.1

For two years, the provision sat unnoticed — until Ted Benna came along. Now known as the “father of the 401(k),” Benna was a benefits consultant for Johnson Companies. When he saw the potential benefit of the provision, he urged his company to implement it into their current employee savings plan.2

By 1984, the new 401(k) approach to retirement saving really took off, with more than 7.5 million plan participants and $92 billion in assets.3 By 1991, the number of participants had reached 48 million, and by 1996, the combined assets of all 401(k) plans surpassed the $1 trillion mark.4

The plan saw major modifications in 2001 when Congress passed the Economic Growth and Tax Relief Reconciliation Act, which allowed participants age 50 and older to make “catch-up contributions.” The Act also allowed companies to offer Roth 401(k) accounts, which make post-tax contributions while providing tax-free growth and distributions — unlike the traditional 401(k).5 Today, 401(k) plans hold more than $5.3 trillion in assets.6

The 401(k) Becomes Our Primary Retirements Savings Vehicle

With such a large volume of participants, and remarkable success, it might come as a surprise that the plan was created unintentionally and not by design. In the late 1980s, the federal government twice tried to invalidate 401(k) plans. There was a large concern that with the plan’s tax-deferral feature, tax receipts would fall too fast as people funded their plans. In fact, it’s estimated that plans cost the government more than $115 billion a year in tax revenues. However, despite the large tax revenue hit, the government encourages the use of 401(k) plans because they reduce government spending on welfare programs for the elderly, as Americans are better funding their own retirement.7

In its earliest days, the 401(k) plan was much more basic than it is now. Its original intended purpose was to serve as a supplemental retirement account to pension plans, with most of the investments being held in company stock.

It did not take long for employers to see the advantages of forgoing the use of traditional pensions and implementing 401(k) plans to replace them. With 401(k) plans, employers saw a significant decrease in the cost of providing retirement benefits to their employees, allowing small-sized firms to stay competitive by offering similar benefits packages to employees as those found in larger companies. Plus, the burden of saving shifted from the employer to the employee.

While this shift caused added responsibility for employees, in return they benefited from the tax advantage and flexibility a pension did not provide. Traditional pension plan payouts typically were based on an employee’s salary and years of experience, but 401(k) plans gave all employees the freedom to choose how much to save, with the opportunity to enroll soon after they began to work for the company. The plan’s design also allowed employees to take their contributed money with them if they changed jobs.8

The past 40 years have been pretty impressive for an almost unnoticed provision in the tax code. As most Americans’ primary tool for saving for retirement, the 401(k) has drastically changed the way we save. Three cheers for 40 years!

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Wipfli Financial Advisors, LLC (“Wipfli Financial”) is an investment advisor registered with the U.S. Securities and Exchange Commission (SEC) under the Investment Advisers Act of 1940. Wipfli Financial is a proud affiliate of Wipfli LLP, a national accounting and consulting firm. Information pertaining to Wipfli Financial’s management, operations, services and fees is set forth in Wipfli Financial’s current Form ADV Part 2A brochure, copies of which are available upon request at no cost or at www.adviserinfo.sec.gov. Wipfli Financial does not provide tax, accounting or legal services. The views expressed by the author are the author’s alone and do not necessarily represent the views of Wipfli Financial or its affiliates. The information contained in any third-party resource cited herein is not owned or controlled by Wipfli Financial, and Wipfli Financial does not guarantee the accuracy or reliability of any information that may be found in such resources. Links to any third-party resource are provided as a courtesy for reference only and are not intended to be, and do not act as, an endorsement by Wipfli Financial of the third party or any of its content or use of its content. The standard information provided in this blog is for general purposes only and should not be construed as, or used as a substitute for, financial, investment or other professional advice. If you have questions regarding your financial situation, you should consult your financial planner, investment advisor, attorney or other professional.
McKenna Girtz
McKenna Girtz

Associate Advisor

McKenna Girtz is an Associate Advisor with Wipfli Hewins Investment Advisors, LLC, based in the Twin Cities.

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The 401(k) Turns 40: How a Minor Provision Created a Powerhouse Savings Plan

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