The History of the 401(k)

The History of the 401(k) 

Most of us of working age are familiar with 401Ks – but do you know the story of how they were created? With more than $29 trillion in US retirement assets as of March 31, 2019, most 401(k)s a crucial part of the economy and one of our specialties at McClure Wealth. We love helping clients create custom 401(k) plans. Read on for background on 401K creation and how it all began. 

The Original Idea

A lot of financial historians will agree that the 401K was created by ‘accident’. A man by the name of Ted Benna is honored as the “Father of the 401K” because in 1980 he innovated and adopted some rules under the IRS Act of 1978 which ultimately led to widespread adoption of the 401K. How did this happen, you may ask? Let us explain below. 

(Ted (Image: Ted Benna, Source: Investment News)

When Congress passed the Revenue Act of 1978, there was a little known provision called Section 401(k) which enabled employees to avoid taxes on deferred compensation. A couple of years later, in 1980, the pioneering Ted Benna, who was a benefits consultant at the time, came up with an idea for a pension-plan client to design tax-friendly retirement vehicles while contributing an employer match. While the client originally rejected the idea, this work inspired Benna to start his own company, The Johnson Companies, which became the very first firm to offer a 401(k) plan to employees. 

Then, to fan the 401(k) flames even more, in 1981, the IRS issued a new rule which allowed participants to fund their 401(k) through payroll deductions, kickstarting the 401(k)’s climb in popularity. Up until that time, employees had not had the opportunity to invest pre-tax retirement savings in any product like it.

The Impact on American Households

According to the Investment Company Institute (ICI), 401(k) plans now hold over $5 trillion in assets at the end of 2018 with approximately 55 million active participants. To say Benna made an impact on the retirement lives of Americans would be an incredible understatement. The chart below illustrates just how measurable Mr. Benna’s original idea has been to the world of investments, wealth management, and retirement savings.

Below is a timeline that illustrates the sequence of events leading up to the mass adoption of the 401(k) and milestones thereafter:

1978: The Internal Revenue Service Act of 1978 with Section 401(k) is passed by Congress 

1981: IRS issues a rule allowing 401(k) funding through salary deductions.

1982: Large companies such as Johnson & Johnson, PepsiCo, and Honeywell start offering 401(k) plans to their employees.

1983: Approximately half of all large employers offer a 401(k) or were considering offering one according to the Employee Benefit Research Institute.

1984: Congress becomes concerned that executives would take advantage of 401(k) plans so The Tax Reform Act of 1984 was passed which required “nondiscrimination” testing to prevent plans from favoring highly compensated employees over less compensated workers.

1996: 401(k) plan assets surpass $1 trillion, with more than 30 million participants enrolled. 

Have more questions about the creation of 401(k)s or want to start one of your own for your company? Give us a call at (760) 607-0611 and we will help your company customize its business 401(k).