History of 401(k) Plans
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 are invested in stocks,
bonds, guaranteed investment contracts (GICs), cash-equivalents,
or a diversified portfolio of these investments. The pre-tax
contributions as well as earnings on an account are taxed only
when withdrawn. Employers generally have the discretion whether
or not to make matching contributions to their workers' 401(k)
plan. Currently (as of December 2000), the maximum annual
contribution that an individual can make to his or her 401(k)
account is $10,500, indexed for inflation.
In recent years, 401(k) plans have
become the fastest-growing type of retirement plan in the United
States. This brief history tracks key events in the development
of 401(k) plans.
1978--The Revenue Act of
1978 included a provision that became Internal Revenue Code (IRC)
Sec. 401(k) (for which the plans are named), under which
employees are not taxed on the portion of income they elect to
receive as deferred compensation rather than as direct cash
payments. Prior to 1978, the Internal Revenue Service (IRS) had
issued a series of Revenue Rulings (Rev. Rul. 56-497, Rev. Rul.
63-180, and Rev. Rul. 68-89) that allowed eligible employees to
elect to receive a portion of their profit-sharing contributions
in cash and defer the noncash portion in a profit-sharing plan on
a pre-tax basis. The Revenue Act of 1978 added permanent
provisions to the IRC, sanctioning the use of salary reductions
as a source of plan contributions. The law went into effect on
Jan. 1, 1980. Dow Jones Industrial Average (at year-end 1978):
1981--The IRS issued
proposed regulations on Sec. 401(k) that sanctioned the use of
employee salary reductions as a source of retirement plan
contributions. Dow Jones Industrial Average at year-end: 875.00.
1984--The Tax Reform Act
of 1984 (TRA '84) modified the rules for 401(k) plans by, among
other things, requiring nondiscrimination testing to ensure that
contributions or benefits under tax-qualified plans do not
discriminate in favor of highly compensated employees by more
than an allowable amount.
Number of plans with a 401(k) feature
(according to U.S. Department of Labor Form 5500 reports):
17,303. Number of active participants in these plans: 7,540,000.
Total assets in these plans: $91.75 billion. Dow Jones Industrial
Average at year-end: 1,211.57.
1986--The Tax Reform Act
of 1986 (TRA '86) tightened up on the nondiscrimination rules,
reduced the maximum annual 401(k) salary deferrals by employees
(under IRC Sec. 402(g)), and required inclusion of all after-tax
contributions to defined contribution plans as annual additions
under IRC Sec. 415 limits (which set the maximum annual
contribution that can be made by both a worker and his or her
1990--Number of plans with
a 401(k) feature: 97,614. Number of active participants in these
plans: 19,548,000. Total assets in these plans: $384.85 billion.
Dow Jones Industrial Average (at year-end): 2,633.66.
Compensation Amendments of 1992 imposed a 20 percent mandatory
withholding tax on lump-sum distributions that are not rolled
over into another qualified retirement plan, annuity, or
individual retirement account (IRA); liberalized rollover rules;
and required plan sponsors to transfer eligible distributions
directly to an eligible plan if requested by the participant.
1996--The Small Business
Job Protection Act of 1996 (SBJPA) provided design-based
"safe harbor" methods for satisfying the
nondiscrimination tests applicable to 401(k) plans, introduced
SIMPLE plans (savings incentive match plans for employees) for
employers with no more than 100 employees, repealed Sec. 415(e)
limits (maximum defined benefit plan promised benefits and
defined contribution plan contributions made to the same
employee), and created a new definition of "highly
Number of plans with a 401(k) feature:
230,808. Number of active participants: 30,843,000. Total assets:
$1.06 trillion. Dow Jones Industrial Average (at year-end):
1998--IRS Notice 98-52,
issued as part of the pension simplification provisions of the
SBJPA, provided guidance on "alternative" or "safe
harbor" methods of satisfying the 401(k) nondiscrimination
requirements in IRC Sec. 401(k)(12). The IRS also issued Rev.
Rul. 98-30, which gave a stamp of approval for employers to make
"negative elections" (i.e., automatic enrollment) into
401(k) plans for newly eligible employees ("negative
election" allows workers to be automatically enrolled in
their employer's retirement savings plan if they take no action).
1999--IRS Notice 99-1
issued guidance concerning the use of electronic technologies,
including computer media, in retirement plans. This was done in
response to the Taxpayer Relief Act of 1997, in which Congress
specifically instructed both the IRS and the Department of Labor
to develop guidance and regulations relating to retirement plan
notification, consent, and other employee communications in light
of new technologies.
2000--IRS Rev. Rul. 2000-8
provided additional guidance on "negative elections" by
allowing negative (or automatic) enrollment in 401(k) plans for
already-eligible employees who are deferring at a rate that is
less than the automatic enrollment rate. The IRS also issued IRS
Notice 2000-3 on 401(k) "safe harbor" rules, which
modified Notice 98-52 and provided additional guidance on how to
satisfy the rules.
Number of plans with a 401(k) feature:
327,364. Number of active participants in these plans:
42,135,000. Total assets in these plans: $1.83 trillion. Dow
Jones Industrial Average (as of Nov. 16, 2000): 10,656.03.
For more information, contact Ken
McDonnell, (202) 775-6342, or see EBRI's Web site at
Source: EBRI Databook on