Evolution of the 401(k)

When employer-sponsored 401(k) plans were introduced in the 1980s, an unexpected consequence occurred: Pensions stopped being the norm. One reason is that companies found 401(k) plans less expensive than traditional defined benefit plans.1 At the time, 401(k) plans were touted as an opportunity for greater earnings and a richer retirement lifestyle. While it’s true that potential exists, it has not come to fruition for many of America’s workers. Analysis of data compiled by The Pew Charitable Trusts indicates that only about half of American workers participate in an employer-sponsored retirement plan, including 401(k) plans.2 As a result, many Americans are woefully short on retirement funds and savings. According to recent data from the Economic Policy Institute, households in which wage earners are between ages 50 and 55 years old have a median savings of only $8,000. It’s somewhat better -- $17,000 -- for those ages 56 to 61. Worse yet, a 2016 GOBanking Rates survey found that 35 percent of all U.S. adults have only a few hundred dollars in their savings account; 34 percent have none at all.3 These are averages, of course, but the numbers are bleak. Thirty percent of baby boomers will start retirement with less than $50,000 in savings -- indicating many will rely almost exclusively on Social Security benefits.4If you could use some retirement planning advice, please give us a call. We help our clients make decisions about generating retirement income, using both funds accumulated in employer plans and through individual portfolios, as well as insurance products. In 1978, Congress passed the Revenue Act of 1978, which included a provision for Section 401(k) plans, offering a means for employees to defer compensation from bonuses or stock options from current taxes. The law went into effect in 1980. The following year, the IRS issued rules permitting workers to make tax-deferred contributions to their 401(k) plans directly from wages, which is when their popularity began to explode. By 1983, almost 50 percent of large employers were offering or developing plans.5 It was an easy sell. Employers liked them because they were cheaper to fund with matches, and the expense was more predictable than indefinite pension payments. Employees felt they were in the driver’s seat and could make better investment decisions for higher earnings. These projections turned out well for companies, but perhaps not as well for many employees, as 401(k) accounts rise and fall with the financial markets.6 Automatic enrollments in 401(k) plans, as well as automatic contribution increases each year, appear to have the potential to help Americans save more. According to a study by J.P. Morgan: 7
  • Among workers who automatically enrolled in their 401(k) plans, only 1% opted out and 96% were happy with the feature. Nearly a third of those surveyed said they would not have enrolled in the plan without the automatic enrollment feature.
  • Among those whose contributions were automatically increased each year, 97% were satisfied, and 15% said they likely would not have increased contributions on their own.
In 2006, a new rule allowed employers to offer Roth 401(k) plans, either as a separate plan or as part of their retirement program. The Roth 401(k) is funded with already taxed income, the earnings grow tax-free and qualified withdrawals made during retirement are not taxed.8 For now, 401(k) plans are a primary retirement savings vehicle for American workers. However, one of the caveats is that those tax-deferred income contributions and earnings deprive the government of revenues that could be used to reduce the deficit or for new spending programs. With new deficit concerns on the horizon, the tax status of 401(k) funds could be subject to greater scrutiny in the future.9
1Kelley Holland. CNBC. March 23, 2015. “For millions 401(k) plans have fallen short.” Accessed Dec. 29, 2017.  2 The Pew Charitable Trusts. January 2016. “Who’s In, Who’s Out.” Accessed Jan. 11, 2018.  3Ester Bloom. CNBC. June 13, 2017. “Here’s how many Americans have nothing at all saved for retirement.” Accessed Dec. 19, 2017.  4Suzanne Woolley. Bloomberg. Dec. 13, 2017. “Retirement, Delayed.” Accessed Dec. 19, 2017.  5Kathleen Elkins. CNBC. Jan. 4, 2017. “A brief history of the 401(k), which changed how Americans retire.” Accessed Dec. 19, 2017.  6Ibid  7Dan Kadlec. Money. July 27, 2016. “The 401(k) Features Employers Can No Longer Ignore.” Accessed Dec. 19, 2017.  8Denise Appleby. Investopedia. Nov. 30, 2015. “Roth 401(k), 403(b): Which Is Right for You?” Accessed Dec. 14, 2017.  9Suzanne Woolley. Bloomberg. Nov. 15, 2017. “Why Republican Lawmakers Are Eyeing 401(k)s for Their Tax Plan.” Accessed Dec. 29, 2017. 

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