A 401(k) is a kind of retirement fund. The strange name comes from the section of the US Internal Revenue Code that determines the 401(k)’s tax benefits. It’s use a retirement fund was unintended.
In 1978, Congress passed a Revenue Act that included a section enabling employees to defer tax on deferred compensation. Section 401(k) meant that if a company agreed to pay an employee a sum of money but would only give that amount to the employee in the future, the employee wouldn’t be liable for tax on that amount until they received it.
It took a couple of years before benefits consultant Ted Benna saw the opportunity to use the section to create a tax-friendly retirement program for a client. Employees would put money into a fund, and receive a matching amount from the client. Because the employer’s contribution was deferred, the employee wouldn’t have to pay tax on it until they made a withdrawal from the fund.
The client wasn’t crazy about the idea but Benna’s firm, The Johnson Companies, used the system to create its own pension plan. This is similar to an annuity plan.
A year later, the IRS made the idea official by issuing new rules. Employees could now fund their 401(k) directly from payroll deductions. In effect, they could receive a tax deferment on both their own contributions and the employer contributions. By 1983, almost half of all large companies had either implemented a 401(k) plan or were thinking about it.
- What Is a 401(k)?
- How a 401k Plan Works
- 401k Contribution Limits
- The Difference Between a 401(k) and a Pension
- The Benefits of a 401k
- Four Alternative 401(k) Plans
- How Employers Should Choose a 401(k)
- What Is an Indexed Annuity?
- 5 Questions Employees Should Ask Before Choosing a 401(k)
- Contributing to Your 401(k) Plan
- Contribution Limits
- Matching Contributions
- Your Age
- How to Set Your 401(k) Contribution Targets
- Calculating Your Social Security Benefits
- What’s In Your 401k Plan?
- Track Your 401(k)
- The Present and Future Value of Your 401(k) and Why You Need to Know Them
- Rolling Over Your 401(k)
- You Don’t Have to Rollover Today
- Moving Your 401(k) to Your New Employer With a Direct Rollover
- Moving Your 401(k) to Your New Employer With a 60-Day Rollover
- Borrowing Funds from Your 401(k)
- Lend Yourself Interest-Free 401(k) Funds
- Borrowing from Your 401(k) to Buy a Home