How long has 401k been around?

Employers provide 401(k)s to their employees to help accelerate retirement savings. The funding for the retirement plan comes directly from the employee’s paycheck, and some employers may decide to match employee’s contributions up to a specific limit. In most US companies, 401(k) plans have become the dominant workplace retirement plan.

401(k) has been around for 43 years since the Revenue Act of 1978 was passed into law. 401(k) derives its name from Section 401(k) of the Internal Revenue Code, a provision that allowed employees to avoid taxes when they make deferred contributions to a retirement plan. Ted Benna is considered the “father of the 401(k)” after he conceived the idea of a pre-tax retirement plan in 1980.

History of 401(k)

A 401(k) plan gets its name from section 401(k) of the Revenue Act of 1978. This act allowed employees to defer compensation from stock options and bonuses. Essentially, this act allowed employees to avoid being taxed on the amount they deferred for their retirement. However, nobody paid attention to the Section 401(k) provision until 1980.

When Ted Benna was approached by a bank client to create a tax-friendly retirement program for its employees, he referred to Section 401(k) in his research. He devised an idea that would allow employees to set aside pretax money in a retirement plan, while also collecting an employer's match. However, Benna's client rejected this idea, but his company, The Johnson companies took up the idea and became the first company to provide a 401(k) plan for its employees.

In 1981, the IRS revised rules for 401(k) to make it a formal retirement plan for workers. The new rules encouraged employers to offer 401(k) plans to their employees. Employees could then make deferred contributions and use the accumulated savings to make investments without paying taxes on investment gains. By 1983, there were 7.4 million American workers enrolled in 401(k) plans across the US, and this number has risen to over 80 million people and over $7.3 trillion assets under management.

Key Timelines in the History of 401(k)s

Since 1978, 401(k) has achieved many milestones over the years. Here are the key highlights:

1978- Congress passed the Revenue Act, which included Sec 401(k) that allowed employees a tax-free way to defer compensation.

1981- IRS issued new rules that allowed the funding of 401(k) plans through payroll deductions.

1983- About half of large US companies had a 401(k) plan for their employees, or were considering introducing a 401(k) plan.

1984-The enactment of the Tax Report Act introduced non-discrimination testing to prevent the deferred contribution plan from favoring highly compensated employees over lower-paid employees.

1996- 401(k) plans reached 30 million participants and a record $1 trillion in assets.

2001- The EGTRRA Act introduced catch-up contributions for 401(k) participants who were above age 50. The act also introduced Roth 401(k)s to allow participants to make after-tax contributions.

2006- The Pensions Protection Act introduced automatic enrollment of employees into 401(k) plans.

2021- 401(k) plans held $7.3 trillion in assets, representing 1/5 of the US retirement market.

Who is Ted Benna?

Ted Benna is considered the "father of 401(k)" due to his role in the creation of 401(k). At the time, Benna was a benefits consultant at the Pennsylvania-based Johnson companies, a company that he co-owned. In 1978, Benna was hired to create a retirement plan for a banking client, but the client declined the suggested solution on the basis that the idea had not been used.

After the retirement plan was rejected, he persuaded his own company to use the plan for its employees. The company's full-time employees were allowed to fund their retirement plans with pretax money, and still receive matching contributions from the employer. The accidental birth of 401(k) plans opened the way for the use of 401(k) plans as the primary retirement vehicle for most employers by the mid-1980s.

How 401(k) Plans Work

If your employer offers a 401(k) plan, you should check if you are eligible to join and start contributing money for your retirement. Usually, most employers offer automatic enrollment when an employee completes a certain number of months in the company.

Employees must decide how much to contribute to the plan, and the employer will deduct the contributions directly from their paycheck. However, there is a maximum annual contribution limit that you should not exceed. For 2022, the maximum limit is $20,500, while those above 50 can contribute up to $27,000.

Employees may have a choice between two types of IRAs i.e. traditional 401(k) and Roth 401(k). For a traditional IRA, you will contribute pre-tax money, and the funds will grow tax-deferred over your active working years. The contributions will help you lower your taxes now, and you won't pay taxes on contributions or investment earnings until when you withdraw money in retirement.

In comparison, a Roth 401(k) is funded with after-tax money, meaning you pay taxes on the contributions upfront. Since you have already paid taxes, you won’t pay further taxes again when you withdraw money in retirement.