The Origin of the 401(k) Plan (Quick Review)
Where did the idea for a 401(k) plan originate? Why is it called a “401(k) plan” in the first place? And why have 401(k) plans become so difficult for small businesses to administer over the years? For the answers, we have to go back in time— back to the year 1978.
Tax Tweaks in 1978
Over the course of many decades, the Internal Revenue Code of the United States has been amended and reworked multiple times. Among many other topics, it includes some sections dealing with various defined contribution plans provided by employers. The Revenue Act of 1978 inserted some new material to deal with the tax requirements for profit-sharing programs. Under section 401, subsection “k,” was a provision that went relatively unnoticed for a couple of years.
The 401(k) portion of the Internal Revenue Code permitted employees to avoid taxes on some of their income, as long as they chose to receive the money at a later time. Instead of direct pay, the money would be considered “deferred compensation,” and as such, would not be taxable.
A Game-Changing Discovery
In 1980, Ted Benna, a benefits consultant, was reviewing the Internal Revenue Code and realized the implications of subsection 401(k). He had the idea of separate accounts which companies could fund for their employees. These accounts would hold the deferred compensation and serve as a way to avoid some taxes and save up money for the future.
Since the original wording of section 401(k) did not allow specifically for such accounts, Benna presented his idea to the Internal Revenue Service and asked them to change that portion of the tax code. The IRS reacted with uncharacteristic speed, making the alterations in 1981, just a year later.
The Rapid Growth of the 401(k) Plan
In 1982, shortly after the IRS adjusted section 401(k), a number of big companies started 401(k) programs for their employees. The employees could set aside a specific amount of their salary as non-taxable deferred compensation. They could then invest that deferred income and use their gains to save up for retirement or other needs.
By 1983, over 7 million employees across the United States were participating in 401(k) plans. The number skyrocketed to 48 million within 10 years and has continued to grow ever since.
Concerns over discrimination prompted the Tax Reform Act of 1984. In this act, the government stipulated “non-discrimination” testing to make sure that the 401(k) plans were not merely catering to highly paid professionals and executives. The new non-discrimination requirement ensured that regular employees would be able to reap the benefits as well. As well-intentioned as this intervention was, it didn’t eliminate the risk of increasing complexity, fees, and administration entanglements for 401(k) plans.
Automatic Enrollment in 401(k) Plans
When it was first created, the 401(k) plan was intended to be completely voluntary. It was simply an additional option among other choices available to America’s workforce. At the time, neither Benna nor other proponents of the program anticipated it becoming the foundational, crucial part of the retirement system that it is today.
Eventually, however, the 401(k) became a coveted part of a company’s employee benefits package. In 2006, automatic enrollment became an option for employers, thanks to the Pension Protection Act. Since 2006, when someone joins a company that offers a 401(k) plan, they could be automatically enrolled and given their own 401(k) account.
The Big Business of 401(k) Programs
Currently, the United States has over $6.2 trillion tied up in 401(k) plans. That’s 80 million people relying on this system for their retirement security!
The complexity of the plans has also increased since their inception. As you can imagine, GREED has played a major role in the direction of this 40 year old industry. We are now seeing a 401(k) revolution to provide a way for small businesses to offer a plan. Reducing the costs and complexity of 401(k) plans takes them back to the early days, restoring them to the simplicity and functionality that Ted Benna envisioned in 1980.
If you’re looking for a simpler, easier way to offer your employees 401(k) benefits, visit 401go.com. We cut out all the layers of red tape and the multiple middle-men, and we provide clarity, simplicity, and practical benefits for small businesses and startups that want 401(k) plans. Let’s take the 401(k) back to what it was originally intended to be— a money-saving break for hard-working Americans.
(Sources Consulted: http://www.401go.com/, https://www.learnvest.com/knowledge-center/your-401k-when-it-was-invented-and-why/, http://www.morningstar.com/advisor/t/104768242/a-brief-history-of-401-k-s.htm,
(Sources Consulted: http://www.401go.com/, https://www.learnvest.com/knowledge-center/your-401k-when-it-was-invented-and-why/, http://www.morningstar.com/advisor/t/104768242/a-brief-history-of-401-k-s.htm, https://www.americanbenefitscouncil.org/pub/e613e1b6-f57b-1368-c1fb-966598903769https://en.wikipedia.org/wiki/401(k), http://www.investopedia.com/ask/answers/100314/why-were-401k-plans-created.asp)