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The History of 401(k) Plans and How They’ve Evolved

Gusto Editors  
Older couple reviewing the evolution of their 401K plans

Can you explain the benefits of having a 401(k) to your clients?

As an accountant, your small business clients count on you to demystify different tax concepts and classifications to promote the success of their companies. Your clients need to be aware of work-based retirement plans that affect their employees. 

Fortunately, Gusto, along with our partners at CPA Academy, presented an informative webinar about different retirement investment plans. We delivered the webinar titled, “Private Sector 401(k) vs. State-Sponsored IRA: A Guide for Accountants,” and you can watch the entire presentation here. The webinar featured the retirement and tax expertise of Nicolle Wilson, director of the retirement consulting department at Guideline

In this article, we’ll share helpful insights from Nicolle’s presentation. You’ll learn about the Employee Retirement Income Security Act, the history of 401(k)s, and Roth IRAs. 

What is ERISA? 

Before 401(k)s became common in the American workplace, the United States Congress passed the Employee Retirement Income Security Act (ERISA) of 1974. Congress created the act to offer protection to individuals who have qualified retirement plans. Nicolle noted that the definition of a qualified tax plan is a plan covered by ERISA: 

What are qualified retirement plans? They are, by circular definition, just plans that are covered by ERISA. These include both defined benefit pension plans as well as defined contribution plans.

Nicolle Wilson 

Defined benefit pension plans are plans that include pre-established benefits for employees that they receive when they retire. Employers primarily contribute to the funds within the defined benefit plan. Within a defined contribution plan, employees contribute to their own retirement plans. ERISA aimed to protect individual’s retirement plans and give employees more control over their retirement: 

ERISA was passed so that plan participants had some visibility into the workings of their retirement plan, as well as protection from any suspicious maneuvers or dealings. So, ERISA was a big step towards encouraging employees to participate in their own retirement journey, as opposed to just letting their employer … set the tone for their retirement.

Nicolle Wilson 

Through ERISA, employees have more control over their retirement plans. One of the most long-lasting impacts of Congress passing ERISA is the development of 401(k) plans

Employees standing beside each other waiting to view their 401(K)s

What is a 401(k) plan? 

A 401(k) is a defined contribution retirement plan in which an employee can put aside some of their salary to invest in retirement. The 401(k) started when Congress passed the Revenue Act of 1978, adding a new provision called Section 401(k) to the Internal Revenue Code. Although Congress added Section 401(k) to the tax code in 1978, it wasn’t until 1980 that someone used the 401(k) provision:

In 1980, Ted Benna, a retirement benefit consultant, got creative and designed the first-ever 401(k) plan for a client who actually rejected it for fear of getting in trouble with the IRS. Benna, instead, implemented it for the company he worked for at the time. … Then a year later, in 1981, the IRS formally allowed employees to fund their 401(k) accounts with payroll deductions.

Nicolle Wilson 

Originally, the IRS intended 401(k)s to add to employees’ pension plans rather than replace them, but companies shifted their focus from pension plans to 401(k)s:

Eventually, businesses came to prefer 401(k) plans since they were more cost-effective and less complex. What that led to is a transition from pension plans, where the employer is responsible for funding employee retirement accounts, to 401(k)s where the employee is now mostly in charge of building their own retirement nest egg.

Nicolle Wilson 

401(k)s are the primary source of retirement savings. As of December 2020, 401(k)s comprise one-fifth of the United States’ retirement market and are worth a combined $6.7 trillion in assets. 

Although 401(k)s are incredibly common, the United States has a significant retirement crisis. Nicolle noted that many Americans are not saving enough for retirement:

According to a 2019 AARP article, 48% of Americans aged 55 and older don’t have any retirement funds at all. … The consequences of the savings shortfall can be quite severe for individuals and, eventually, it will affect the economy at large. … The average American savings account has $41,700 in it, … but if you look at the median savings account, we see [it’s] only $5,300. When the median is considerably lower than average, you know that most people in the country actually have much less than average saved.

Nicolle Wilson 

The median amount saved indicates that most Americans are not saving enough for retirement. Once individuals reach retirement age and don’t have a significant retirement account, they rely on social security. Social security was only designed to supplement 40% of pre-retirement income, meaning that individuals can’t cover the entirety of their expenses through social security alone.  

Roth IRA plans for the private sector

Millions of people don’t have access to a 401(k) or any other workplace retirement plan. The lack of workplace retirement plans is incredibly detrimental to individuals’ savings because people are far more likely to save money through a workplace plan:

It turns out that 33% of private-sector workers or 41 million people in the US are not able to save for retirement through their workplace. … Individuals are much more likely to save for retirement through a workplace plan. In fact, they are 15 times more likely to do so, according to AARP.

Nicolle Wilson 

Some states implemented auto-enrolled Roth IRA plans because individuals are far less likely to save outside of a workplace plan. Individual retirement arrangements (IRAs) enable people to save towards retirement with tax-free or tax-deferred growth. With Roth IRAs, individuals contribute to retirement with money that’s already been taxed, meaning that people can potentially grow their retirement accounts without paying additional taxes as long as they follow IRS provisions

Employer reviewing options for their employees 401(K)s

The financial responsibility of setting up an IRA falls on employees rather than employers:

IRA plans can be set up with no cost to the employer. Instead, the cost is borne by the employee through an [Assets Under Management] AUM fee on their account balance. This cost is supposed to remain relatively low. … [It] generally means 1% of assets annually or less.

Nicolle Wilson 

Many states now auto-enroll employees into IRA tax plans, meaning that individuals need to opt out or else part of their salary goes toward their IRA. The majority of workers who are auto-enrolled in IRA programs do not opt out: 

Approximately 75% of workers said they would stay in the program, and only 10% would opt out of the program altogether. So, if you have the vast majority of workers who currently don’t have access to a retirement plan … wanting someone to force them to save, then you start to think auto-enrollment is a pretty good idea.

Nicolle Wilson 

As of 2020, only California, Illinois, and Oregon require businesses of a certain size to provide employer-sponsored retirement plans or enter the state IRA program. The Employee Benefit Research Institute (EBRI) found that both auto-enrolled IRA programs and 401(k) plans could greatly reduce America’s savings deficit if they were enacted nationwide:

[EBRI] found that if [auto-enrolled IRA plans] were applied nationwide, the $3.83 trillion aggregate retirement savings deficit among American households would fall by 12% or $456 billion. While it would not solve the entire retirement crisis, it really could make a significant dent. And then you can see here in scenario two that if employers all offered a safe harbor 401(k) plan instead, the deficit would fall even more—by $645 billion or 17%.

Nicolle Wilson 

Work-based retirement plans—such as auto-enrolled IRA programs and 401(k)s—can dramatically increase the amount of money that Americans save toward retirement. 

Learn more about the 401(k)s and IRAs

As an accountant, it’s critical to understand the history of 401(k)s and the benefits of having a 401(k). Nearly a third of the US population doesn’t have access to 401(k)s or another work-based retirement plan. It’s crucial for Americans to start saving more money, and people save significantly more when they contribute to work-based retirement plans, which is why some states now require businesses to implement a 401(k) program or join the state IRA program. 

There’s a lot to unpack regarding retirement planning and savings. If you want to learn more about 401(k)s and IRA plans, read Part Two and Part Three of this webinar article series. You can also watch the full webinar here.

If you want to expand your firm while also improving your ability to assist your clients, consider partnering with Gusto! Gusto offers an exceptional People Advisory Certification Program that teaches accountants how to combine their financial expertise with payroll, benefits, and HR so that you can support your clients in an advisory role. If you’re ready to learn more about how Gusto can help your firm and clients, visit our Gusto for accountants page.

Updated: March 31, 2022

Gusto Editors
Gusto Editors


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