YOUR 401(k) #1: HISTORY
401(k) plans are commonplace these days, so you may be surprised to learn that they’re relatively new as far as employee benefits go.
When our parents and grandparents were younger, pensions were all the rage. The goal in their day was to work at the same company, climb the ranks, then retire with a cushy pension.
- Pensions are a type of defined benefit plan - the benefit, or the amount of money the employee is promised to receive in retirement, is defined.
Sounds great, right? So why aren’t they offered as much anymore? Well, about forty years ago, everyone started to realize that pension plans are wayyyy too expensive. Companies had been offering them for decades, but weren’t really paying attention to the performance and viability of the retirement pool. Once accountants started scrubbing the numbers, they realized that companies couldn’t afford to pay out anywhere near as much as they had promised.
- The gap between the amount that companies had promised to pay and the amount they could realistically afford is called an unfunded pension liability.
Companies were desperate for a cheaper alternative, when along came the 401(k). The word 401(k) itself seems confusing, but it’s actually pretty simple. 401(k) stands for section 401, paragraph k of a portion of IRS code. That particular piece of code came from the Revenue Act of 1978 and gave retirement savings certain tax benefits. In 1980, a man named Ted Benna interpreted the code and created the first ever 401(k).
401(k) plans completely changed the game, and not necessarily in a good way. To be clear, a 401(k) is NOT a pension. Three BIG differences between the two are:
- 401(k) plans are a type of defined contribution plan, not a defined benefit plan. That means that the only defined amount is how much money you put into, or contribute, to your account. Unlike a pension, you’re not promised to receive a certain amount when you retire.
- 401(k) plans are funded by YOU, not your employer.
- YOU make the investment decisions, not your employer.
In short, this means that 100% of the responsibility for planning for your financial future has shifted from the companies’ shoulders to YOURS. Planning for retirement is your responsibility now, and yours alone. And while 401(k)s are by no means perfect, they’re what we’ve got. So you should learn how to make the most of them, right? Right.
Now that you know why you have a 401(k), it’s time to own it. Click “Next” below to move on to the next lesson.