We tend to think of 401(k) plans as the bedrock of the
But these plans, named after a section in the InternalRevenue
Code, were actually developed more by accident than by design. When
lawmakers originally established theRevenue 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 InternalRevenue
Service to allow moremoney to be squirreled away in such
##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
for his own employer, The Johnson Cos., that allowed full-time
employees tofund accounts with pre-tax dollars and matching
employer contributions. Benna then asked the InternalRevenue
Service to change some proposed rules under the law that ultimately
led to the widespread adoption of 401(k) plans by employers in the
"I knew it was going to be big, but I was certainly not
anticipating that it would be the primary way people would be
for retirement 30 plus years later," Benna, now semi-retired and
the president of the 401(k) Association, told
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 employersoffer them.
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 toput that contribution in a traditional
401(k), it isn't taxed until you withdraw the money, allowing your
to grow over time without being taxed. (Note: Youwill pay penalties
if you take out the money before a set retirement age, as defined
by the plan.) And, as an added bonus, many employerswill match some
of your contributions.
In its relatively short history -- just 30 years! -- 401(k)
plans have had many milestones:
Congress passes theRevenue Act of 1978, which includes a provision
that allows employees to avoid being taxed on a portion of
that they decide to receive as deferred compensation, rather than
direct pay. The provision becomes InternalRevenue Code Sec.
The I.R.S.issues rules allowing the funding of 401(k) plans through
employee salary reductions.
Several companies-such as Johnson & Johnson, PepsiCo and
Honeywell -- begin tooffer 401(k) plans to their employees. By
1983, nearly half of all large employers either
a 401(k) plan or are consideringoffering one, according to the
Employee Benefit Research Institute.
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
Assets in 401(k) plans surpass $1 trillion, with more than 30
The Economic Growth andTax Relief Reconciliation Act of 2001
provides for catch-up contributions for participants 50 and older,
as well as the creation of Roth 401(k)s, which let after-tax
contributions grow tax-free.
The Pension Protection Act of 2006 allows employers to
automatically enroll employees in 401(k) plans, and offer
as adefault option .
Today's 401(k): Too Big For Its Britches?
The current 401(k) stats are staggering:
- 51 million Americans have more than $3.5 trillion invested in
401(k) plans, which is more than double the $1.6 trillion in
assets held by the plans in 2002, according to theInvestment
- Assets in 401(k) plans represent 18% of the $19.4 trillion
U.S. retirementmarket .
- The averageaccount balance in a 401(k) plan reached $80,900
in the first quarter thisyear . According to
, a large 401(k) plan administrator, that's up 75% from $46,200
low in the first quarter of 2009.
Benna, who's referred to as the "Father of the 401(k)," has
actually been critical of his creation as of late, noting that
there are too manyinvesting options available today and that their
complexity has a negative impact on 401(k) plan participants.
"This monster is out of control. We went to three options, then
to six, then to seven, then to 15 -- it is far beyond what most
participants were able to deal with," Benna told
magazine. "And I am not convinced we have added value by getting
The original 401(k) plan had only twoinvesting options: astock
fund and a
that guaranteed a return similar to a money market fund. The
typical 401(k) now offers 19 funds.
Some employers have been working to simplify 401(k) plans by
limiting the number of funds on a plan's investment menu, as well
as automatically enrolling workers into target-date funds, which
adjust a portfolio ofstocks andbonds as a participant approaches
retirement to reduce risk. Today, nearly 70% of 401(k) plans offer
a target-date fund as adefault option , with about 12% of 401(k)
assets invested in such funds.
The 401(k) Effect: Did These PlansKill Pensions?
As 401(k) plans have thrived, traditional pension plans have
declined. According to the Department of Labor, from 1980 to 2008,
the proportion of private workers participating in traditional
pension plans fell from 38% to 20%.
For employers, 401(k) plans are a more enticingoption because
they cost less than traditional pension plans, and they don't carry
liabilities and investment risks. Some 401(k) critics even say that
workers would be better off in traditional pensions.
"We know after 30 years of this 401(k) experiment that people do
worse in 401(k)s than they would have if their money was in a
traditional plan or if it was in a plain vanilla retirement
account," Teresa Ghilarducci, director of the Schwartz Center for
Economic Policy Analysis at The New School for Social Research,
But pensions were never as widely available as 401(k) plans.
"Even in the 'good old days' when 'everybody' supposedly had a
pension, the reality is that most workers in the private sector did
Nevin Adams of the Center for Research on Retirement
Income at the Employee Benefit Research Institute
. "Even among those who did work for an employer that offered a
pension, most in the private sector weren't working long enough
with a single employer to accumulate the service levels you need
for a full pension."
As a result,notes Adams, most workers who have pensions still
rely on a combination of
, in addition to pension income to fund their retirements... and
the number of 401(k) plans continues to grow.
How to Make the Most of Your 401(k)
Despite the growth of 401(k) plans, there's an estimated $6.6
trilliondeficit in what Americans currently have in savings
compared to what theywill actually need in retirement, according to
an analysis by the
Center for Retirement Research at Boston
This shortfall should make maximizing retirement accounts, like
a 401(k) plan, a priority. As of 2013, you can contribute up to
$17,500 into a 401(k) plan, andput in $5,500 more if you're 50 or
If you're not maxing out your 401(k), you should consider
boosting your contribution by 1% every six months. For most of us,
that's about $20 to $50 per paycheck, which you probably wouldn't
miss much. And since most employerswill automatically deduct a
401(k) contribution from your paycheck, it makes the extra savings
easier to stomach.
Your employer may also offer to help you save more: Some 95% of
401(k) plans provide matching contributions, and the average
company contribution is 2.5% of an employee's pay. Matching
policies among 401(k) plans differ depending on the company, but
the most common is a dollar-for-dollar match of up to 6% of an
Even if you have a good 401(k) plan, the most important thing to do
is to startsaving more now because it's hard to make up for lost
time when it comes to building a healthy retirementnest egg .
P.S. -- Need more help with planning your retirement? Check out
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Tom Anderson writes for LearnVest. This article appeared as Your
401(k): When It Was Invented -- And Why.
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