Pre-1978: Cash or Deferred Arrangements
Before the passage of the Employee Retirement Income Security Act (ERISA) in 1974, Cash or Deferred Arrangements (CODAs) were used to fund stock bonus, pension, and profit-sharing plans. These plans allowed employees to defer a portion of their income on a tax-deferred basis, as authorized by the Internal Revenue Service (IRS).
Need information on how to find your 401(k) with your Social Security number? Capitalize can help.
The Revenue Act of 1978
The Revenue Act of 1978 laid the groundwork for the modern 401(k) by creating tax structures around deferred compensation. It was Ted Benna, an employee benefits consultant, who interpreted Section 401 of the Revenue Act of 1978 and created the first-ever 401(k) savings plan for his consulting company, The Johnson Companies, in 1980.
This brief history of the 401(k) demonstrates how Benna’s innovative approach allowed employees to make tax-free rollover contributions and enjoy tax-deferred growth on their investments while employers reduced their own tax liabilities.
1980: “Father of the 401(k)”
For obvious reasons, Ted Benna is often referred to as the “Father of the 401(k).” After creating the first-ever 401(k) savings plan for his company, he used his business connections to provide recommendations to Treasury officials on 401(k) regulations.
Benna’s advocacy played a significant role in the widespread adoption of 401(k) plans across the the country. He continues to support legislation requiring employers to auto-enroll their workers in 401(k) plans, which would encourage more workers to take advantage of these retirement accounts and ultimately retire with higher savings account balances.
1981 and the Adoption of 401(k) Policies
1981 proved to be a pivotal year for 401(k) policies, mostly due to their growing popularity at American businesses. California’s largest industrial employer at the time, Hughes Aircraft, seemed poised to be one of the most prominent companies to adopt the new retirement plan.
But even at the urging of Ethan Lipsig, the company’s legal consultant, the Hughes Aircraft hesitated. The 401(k) was still very new and there were legal gray areas companies had to consider before offering them to employees.
It wasn’t until 1981 when the IRS finally weighed in on the issue. Yes, income deferments for 401(k) savings were legal. The new regulations in place, Hughes Aircraft and other major American companies like J.C. Penney, Johnson & Johnson, and PepsiCo all adopted 401(k) plans.
By the end of 1982, over 7.5 million American workers had their own 401(k).
1984-1986: The Tax Reform Acts
The 1980s were a time of booming economic growth in America but it didn’t take long for regulators to see that, at some institutions, 401(k) programs were being abused.
The Tax Reform Act of 1984, part of the Deficit Reduction Act of 1984, introduced the Actual Deferral Percentage (ADP) test. To this day, these tests ensure that companies don’t unfairly favor highly-paid employees. The 1984 Act is credited with providing a greater number of American workers access to their own deferred compensation retirement plan.
In the fall of 1985, Employee Benefit Research Institute (EBRI) issued a statement expressing concern that this new law would hurt the popularity of the 401(k), but those concerns proved to be unfounded.
More changes to the tax code came just a year later. The Tax Reform Act of 1986 placed contribution limits on the amount a salaried employee could defer into a 401(k) plan. It also introduced non-discrimination rules to ensure that plans did not disproportionately benefit highly compensated employees.
Interestingly, the 1986 Act also provided more legitimacy to the 401(k) by implementing deferred compensation retirement plans for a number of federal employees, as well.
The Small Business Job Protection Act of 1996
The Small Business Job Protection Act of 1996 was enacted to support small businesses by simplifying retirement programs and reducing taxes.
One of the most significant changes introduced by the Act was the creation of SIMPLE (Savings Incentive Match Plan for Employees) plans, which made the employer-matching contribution process more manageable for small businesses. As a result, employer contributions became more accessible to those not working for a large corporation.
The Act brought various other benefits as well, such as lower taxes for small businesses, safe-harbor formulas to eliminate non-discrimination testing, simplified pensions, and an increase in the minimum wage. President Bill Clinton signed the Act into law in 1996.
The legislation played a critical role in helping small businesses compete with larger companies, increasing retirement plan participants at small businesses, and making retirement plan providers more accessible.
2001: The Economic Growth and Tax Relief Reconciliation Act
The Economic Growth and Tax Relief Reconciliation Act revolutionized the American retirement landscape when it was signed into law in 2001. Its main goals were to provide tax relief to hardworking Americans and encourage economic growth.
The Act introduced several key changes to retirement plans, such as allowing catch-up contributions for employees aged 50 and older and requiring faster vesting timeframes for matching contributions. One of the most notable changes was the introduction of the Roth 401(k).
A Roth 401(k) is a retirement savings account that allows employees to contribute after-tax dollars, meaning the account owner pays taxes now rather than on withdrawals later in life as a retiree. This is particularly beneficial when the account has appreciated in value or future tax rates have increased. According to a 2019 report from the Transamerica Center for Retirement Studies, millennials are more likely to contribute to Roth 401(k)s than older generations.
Consider the benefits of a Roth 401(k) and consult with a financial advisor to determine if it is the right choice for your retirement savings strategy.
2006: The Pension Protection Act
By 2006, it was clear that many Americans were not saving enough for retirement, prompting lawmakers to pass the Pension Protection Act. The Act aimed to encourage more people to save for retirement by making it easier for companies to offer 401(k) plans.
One of the most significant changes this legislation introduced to the Internal Revenue Code (IRC) was automatic enrollment, allowing companies to automatically enroll employees in a 401(k) plan unless the employee opted out. This helped overcome employee inertia, which often led to workers not enrolling in a plan even if it was offered.
The Pension Protection Act also introduced other changes to 401(k) plans, such as making it easier for employers to offer investment advice to employees and allowing employees to roll over their retirement savings into a Roth IRA.
The automatic enrollment feature of the Pension Protection Act has been credited with increasing participation in 401(k) plans. Some companies even went further and automatically increased their employees’ contributions by 1% a year, leading to even greater savings for retirement benefits, retirement age, and retirement funds.
Now, it’s common for people to accumulate these 401(k) accounts as they move from job to job… and sometimes forget about them. Capitalize can help you track them down.
2022: The Securing a Strong Retirement Act
In recent years, the disappearance of pensions and the fact that people are living longer than ever before has put a strain on retirement savings. The Securing a Strong Retirement Act, also known as SECURE 2.0, is currently making its way through Congress. This legislation builds on the SECURE Act of 2019, which made retirement plans more accessible to part-time workers and small businesses.
The SECURE 2.0 legislation would make enrollment in a retirement savings plan mandatory for employees, which is a significant change. Additionally, it would allow Americans over 50 to contribute even more to their retirement accounts.
Many Americans are still not currently saving enough for retirement, and these changes could help address that issue. To learn more about the legislation or retirement planning in general, consider exploring articles about retirement planning strategies or review the text of the SECURE 2.0 legislation itself.
The Impact of the 401(k)
When discussing the impact of the 401(k), it’s important to consider both its positive effects and its criticisms and drawbacks. The 401(k) has increased accessibility to retirement savings plans, enabled employees to take control of their own retirement planning, and provided tax benefits.
However, potential drawbacks include high fees, limited investment options, risk of market volatility, and insufficient savings for many Americans.
The 401(k) has become a staple of American retirement planning, leading to a greater focus on individual responsibility for retirement savings. It has also impacted how other types of retirement plans, such as traditional pension plans, are structured and managed.
Need Help Rolling Over Your 401(k)?
A 401(k) retirement plan can offer several benefits and drawbacks, making it essential to carefully consider whether it’s the right choice for you. Capitalize has a team of experts that helps people find and roll over their old 401(k) accounts for free.
If you’re interested in learning more about how Capitalize can help, get in touch with our team today.
