401(k) Plans were Designed for an Employee's Retirement
A 401(k) plan is a cash or deferred arrangement under which a covered employee can elect to have a portion of his or her compensation (otherwise payable in cash) contributed to a qualified retirement plan as a pre-tax reduction in salary (however, some plans also accept after-tax contributions from employees). Assets may be invested in a wide variety of investment vehicles such as (but not exclusive to) stocks, bonds, guaranteed investment contracts (GICs), cash-equivalents, or a diversified portfolio of these and other investments.
In a 401(k), the pre-tax contributions and earnings on an account are taxed only when withdrawn. Employers have the discretion whether or not to make matching contributions to their workers' 401(k) accounts. Currently (for calendar year 2009), the maximum annual deferral that an individual can make to his or her 401(k) account is $16,500.
History of 401(k) Plans
1978 In 1978, Congress amended the IRS Code by adding section 401(k), whereby employees are not taxed on income they defer into a retirement plan rather than direct compensation. The section 401(k) law went into effect on January 1, 1980, and by 1983 nearly half of large firms were either offering a 401(k) plan or considering doing so.
Although originally intended for executives, the section 401(k) plan became popular with workers at all levels because it had higher contribution limits per year than the Individual Retirement Account (IRA); it typically came with a company match, and in many ways provided more choices than the IRA, often providing loans and, if applicable, offered employer's stock as an investment option.
1981 The IRS issued proposed regulations on 401(k) plans that sanctioned the use of employee salary reductions as a source of retirement plan contributions. Many employers replaced older, after-tax thrift plans with 401(k)s and added 401(k) options to profit-sharing and stock bonus plans. Within two years, surveys showed that nearly half of all large firms were either already offering a 401(k) plan or considering one.
1984 The Tax Reform Act of 1984 modified the rules for 401(k) plans by, among other things, requiring testing to ensure that contributions under tax-qualified plans do not favor executives over employees by more than an allowable amount.
Number of plans with a 401(k) feature: 17,303. Number of participants in these plans: 7,540,000. Total assets in existing plans: $91.75 billion.
1986 The Tax Reform Act of 1986 (TRA '86) tightened the nondiscrimination rules and reduced the maximum annual 401(k) before-tax salary deferrals.
1990 Number of plans with a 401(k) feature: 97,614. Number of participants in these plans: 19,548,000. Total assets in existing 401(k) plans: $384.85 billion.
1992 The 1992 Unemployment Compensation Amendments required that 20% of withholding tax be required on lump-sum distributions that are not rolled over into another qualified retirement plan, annuity, or individual retirement account (IRA). In addition, this plan required plan sponsors to transfer distributions directly to an eligible plan if requested by the participant.
1996 Number of plans with a 401(k) feature: 230,808. Number of participants: 30,843,000. Total assets: $1.06 trillion.
1998 IRS issued Rev. Rul. 98?30, which gave a stamp of approval for employers to make automatic enrollments into 401(k) plans for newly eligible employees. Number of plans with a 401(k) feature: 300,593. Number of participants: 37,114,000. Total assets in plans: $1.54 trillion.
2003As of year-end 2003, estimated number of plans with a 401(k) feature: 438,000, with combined assets estimated to be $1.9 trillion and 42.4 million current participants.
