An ‘Unintended’ Consequence

"Unintended consequences" are often a euphemism for something bad. But not always. Take the 401(k), for example.

While the nation turns its attention to Election Day, Nov. 6 happens to be the “birthday” of the 401(k). Well, kind of. It’s actually the anniversary of the day on which the Revenue Act of 1978 — which included a provision that became Internal Revenue Code (IRC) Section 401(k) — was signed into law by then-President Jimmy Carter. 

That wasn’t the “point” of the legislation of course — it was about tax cuts (some things never change). It reduced individual and corporate tax rates (pulling the top rate down to 46% from 48%), increased personal exemptions and standard deductions, made some adjustments to capital gains and created flexible spending accounts. 

But it did, of course, also add Section 401(k) to the Internal Revenue Code.

That said, so-called “cash or deferred arrangements” had already been around for a long time — basically predicated on the notion that if you don’t actually receive compensation (frequently an annual bonus or profit-sharing contribution in those times/employers), you don’t have to pay taxes on the compensation you hadn’t (yet) received.

That approach was not without its challengers (notably the IRS) and, according to the Employee Benefit Research Institute (EBRI), this culminated in IRS guidance in 1956 (Rev. Rul. 56−497), which was subsequently revised (seven years later) as Rev. Rul. 63−180 in response to a federal court ruling (Hicks v. U.S.) on the deferral of profit-sharing contributions.

Enter the Employee Retirement Income Security Act of 1974 (ERISA), which — among other things — barred the issuance of Treasury regulations prior to 1977 that would impact plans in place on June 27, 1974. That, in turn, put on hold a regulation proposed by the IRS in December 1972 that would have severely restricted the tax-deferred status of such plans. But ERISA also mandated a study of salary reduction plans — which, in turn, influenced the legislation that ultimately gave birth to the 401(k).

So, how did something that became America’s retirement plan get added to a tax reform package? Rep. Barber Conable, top Republican on the House Ways & Means Committee at the time, whose constituents included firms like Xerox and Eastman Kodak (which were interested in the deferral option for their executives), promoted the inclusion which added permanent provisions to “the Code,” sanctioning the use of salary reductions as a source of plan contributions. The law went into effect on Jan. 1, 1980, and regulations were issued Nov. 10, 1981 (which has, at other times, also been cited as a “birthday” of the 401(k), since that was what allowed/encouraged employers to act on it).

The ‘Fathers’ of the 401(k)

Now, it’s said that success has many fathers, while failure is an orphan. The most commonly repeated story is that Ted Benna saw an opportunity in this new provision, recommended it to a client (which, ironically, rejected the notion), but then promoted it to a consulting firm (The Johnson Companies), which then embraced it for their own workers. The reality is almost certainly more nuanced than that, though Mr. Benna (who has in recent times derided what he ostensibly created) has managed to be deemed the “father” of the 401(k) by just about every media outlet in existence.

What we do know is that in the years between 1978 and 1982, a number of firms (EBRI cites not only The Johnson Companies, but FMC, PepsiCo, JC Penney, Honeywell, Savannah Foods & Industries, Hughes Aircraft Company and a San Francisco-based consulting firm called Coates, Herfurth, & England) began to develop 401(k) plan proposals, many of which officially began operation in January 1982.

Now, it’s long been said that 401(k)s were never intended (nor designed) to replace defined benefit pensions — true enough.

But consider that in 1979 only 28% of private-sector workers participated in a traditional defined benefit (DB) plan, with another 10% participating in both a DB and a DC plan. In contrast, the Bureau of Labor Statistics reports that 70% of private industry workers had access to a defined contribution plan in 2024. As of December 2023, American workers have set aside nearly $11 trillion in defined contribution plans — and there’s another $11.4 trillion in traditional IRAs, nearly three-quarters of which were opened with rollovers (likely from DC/401(k) plans). 

The reality is that the nation’s baseline retirement program is, and remains, Social Security. But for those who hope to do better, for those of even modest incomes who would like to carry their current standard of living into post-employment, the nation’s retirement plan is, and has long been, the 401(k). And despite a plethora of media coverage and academic hand-wringing that suggests they are wasting their time, the American public has, through thick and thin, largely hung in there — when they are given the opportunity to do so.

That may not have been the intent of the architects of the 401(k), or its assorted foster “parents” over the years. But these days it’s hard to imagine retirement without it.

So, happy birthday, 401(k). And here’s to many more!

Nevin E. Adams, JD

I know that some would argue that workers effectively bargained for lower wages in return for the pension benefit. Maybe once upon a time, certainly in labor situations where there actually was an active bargaining component. But I suspect that most non-union private sector workers post-ERISA felt no such trade-off.  

Happy Birthday, ERISA!

Pensions were not on my mind in 1974, certainly not on Labor Day of that year. 

While I was pondering my new college textbooks (and trying to figure out how I was going to pay for $.55/gallon gasoline), President Gerald R. Ford, less than a month in that role—and, appropriately enough on Labor Day, signed into law the Employee Retirement Income Security Act of 1974—better known to most of us as ERISA.

Little did I know at the time that that law—and the structure it provided to the nation’s private pension system—would, in the years to follow, play such an integral role in my life. And yet, in a wide variety of positions, and a handful of different organizations and locations, from that first college internship in 1977 to—well, today—retirement has been my career.

ERISA did not create pensions, of course; they existed in significant numbers prior to 1974. A major motivation for ERISA was the termination of the Studebaker[i] pension plan for its hourly workers in 1963.  At the time, the plan covered roughly 10,500 workers, 3,600 of whom had already retired and who—despite the stories you sometimes hear about Studebaker—received their full benefits when the plan was terminated.

However, some 4,000 workers between the ages of 40 and 59—didn’t. They only got about 15 cents for each dollar of benefit they had been promised, though the average age of this group of workers was 52 years with an average of 23 years of service (another 2,900 employees, who all had less than 10 years of service, received nothing). And so, armed with the real life example of those Studebaker pensions, highlighting what had been a growing concern about the default risk of private sector plans (public sector programs weren’t seen as being vulnerable to the same risk at that time)—well, it may have been a decade before ERISA was to become a reality, but the example of Studebaker’s pensions provided a powerful and on-going “real life” reminder of the need for reform.

In fact, ERISA was designed to regulate what was there and would yet come to be—to protect the funds invested in those plans for the benefit of participants and beneficiaries with a consistent set of federal standards. And, as part of that protection, to establish the Pension Benefit Guaranty Corporation (PBGC).  As President Ford said at the time, “It is essential to bring some order and humanity into this welter of different and sometimes inequitable retirement plans within private industry.”

Has ERISA “worked”? Well, in signing that legislation, President Ford noted that from 1960 to 1970, private pension coverage increased from 21.2 million employees to approximately 30 million workers, while during that same period, assets of these private plans increased from $52 billion to $138 billion, acknowledging that “[i]t will not be long before such assets become the largest source of capital in our economy.” Today, that system has grown to exceed $12 trillion (and another 11.5 trillion in IRAs, much of which came from that private retirement system), covering more than 97 million active workers (142 million in total) in more than 746,000 plans. 

The composition of the plans, like the composition of the workforce those plans cover, has changed significantly over time. While much is made about the perceived shortcomings in coverage of the current system, the projections of multi-trillion dollar shortfalls of retirement income, the pining for the “good old days” when (people act like) everyone had a pension (that never really existed for most), the reality is that ERISA—and its progeny—have unquestionably allowed more Americans to be better financially prepared for a longer retirement. Indeed, the Labor Department recently reported that plans disbursed $266 billion more than they received in contributions[ii] during 2020.

Forty-nine years on, ERISA—and the nation’s retirement challenges—may yet be a work in progress. But it’s hard to imagine American retirement without it, and the individuals who gave it “birth.” 

Happy birthday, ERISA!

- Nevin E. Adams, JD 

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[i] I’d wager that a majority of Americans have never even heard of a Studebaker, and the notion that a major U.S. automobile maker once operated out of South Bend, Indiana would likely come as a surprise to most. The Studebaker brothers (there were five of them) went from being blacksmiths in the 1850s to making parts for wagons, to making wheelbarrows (that were in great demand during the 1849 Gold Rush) to building wagons used by the Union Army during the Civil War, before turning to making cars (first electric, then gasoline) after the turn of the century. Indeed, they had a good, long run making automobiles that were generally well regarded for their quality and reliability (their finances, not so much) until a combination of factors (including, ironically, pension funding) resulted in the cessation of production at the South Bend plant on Dec. 20, 1963.

[ii] Though in total, contributions (DB and DC) increased by 3.2%, to $694.2 billion.

 

"Class" of 74

Pensions were not on my mind in 1974, certainly not on Labor Day of that year.  While I was pondering my new college textbooks, President Gerald Ford, less than a month in that role, signed into law the Employee Retirement Income Security Act of 1974 – better known to most of us as ERISA. Little did I know at the time that that law – and the structure it provided to the nation’s private pension system – would, in the years to follow, play such an integral role in my life.

ERISA did not create pensions, of course; they existed in significant numbers prior to 1974.  Rather, it was designed to regulate what was there and would yet come to be – to protect the funds invested in those plans for the benefit of participants and beneficiaries with a consistent set of federal standards.  And, as part of that protection, to establish the Pension Benefit Guaranty Corporation (PBGC).  As President Ford said at the time, “It is essential to bring some order and humanity into this welter of different and sometimes inequitable retirement plans within private industry.”

Has ERISA “worked”?  Well, in signing that legislation, President Ford noted that from 1960 to 1970, private pension coverage increased from 21.2 million employees to approximately 30 million workers, while during that same period, assets of these private plans increased from $52 billion to $138 billion, acknowledging that “[i]t will not be long before such assets become the largest source of capital in our economy.”  Today that system has grown to exceed $17 trillion, covering more than 85 million workers in more than 700,000 plans.

The composition of the plans, like the composition of the workforce those plans cover, has changed over time.  While much is made about the perceived shortcomings in coverage of the current system, the projections of multi-trillion dollar shortfalls of retirement income, the pining for the “good old days” when everyone had a pension (that never really existed for most), the reality is that ERISA—and its progeny—have unquestionably allowed more Americans to be better financially prepared for a longer retirement. 

Forty years on, ERISA – and the nation’s retirement challenges – may yet be a work in progress.  But, by any measure, this “class of 74” has done the nation a great service.

-          Nevin E. Adams, JD