And then you went to four, five, six [options], and so on. The primary reason this happened over the years is that employers got pressured [by employees who wanted to add specific mutual funds] into including more and more funds. Participant costs increased from roughly 0.
More complexity also opens doors for employees to make poor choices. Could target-date funds be the answer to what ails most plans? Had that type of structure been available back at the beginning when this whole thing started, that would have been the way to go. Rather than attempting to create huge portfolios that have the kind of diversity recommended, and expecting participants to apply that on their own, these take the decision out of it.
I would start by requiring that all employers who have a certain number of employees, whether that be five, 10, or whatever, to offer some form of payroll-deduction retirement program. Another significant issue is what is referred to as leakage—that too much money escapes the system when people change jobs. So, I would eliminate withdrawals when those events happen. The money has to stay either in a k or an IRA until retirement. I would also eliminate lump-sum options when people retire.
Email: editors barrons. Distribution and use of this material are governed by our Subscriber Agreement and by copyright law. For non-personal use or to order multiple copies, please contact Dow Jones Reprints at or visit www. We've detected you are on Internet Explorer. For the best Barrons. Google Firefox. The name comes from a section of the Internal Revenue Code that permits an employer to create a retirement plan to which employees may voluntarily contribute a portion of their compensation on a pre-tax basis.
This section also allows the employer to match employee contributions with tax-deductible company contributions, or to contribute additional funds to employee accounts at the company's discretion as a form of profit-sharing.
Earnings on all contributions are allowed to accumulate tax-deferred until the employee withdraws them upon retirement. In many cases, employees are able to borrow from their k accounts prior to retirement at below-market interest rates.
In addition, employees may decide to roll over funds in their k accounts to another qualified retirement plan without penalty if they change jobs.
Popularity of k plans during the s and s has been great. For the first time ever, in , k type defined-contribution plans surpassed the more traditional defined-benefit pension plans in terms of the total retirement assets held by each. And the growth of defined-contribution plans continued thereafter. According to the Employee Benefit Research Institute, as of the close of , defined-contribution plans held 61 percent of private-sector retirement assets, compared with 39 percent in defined-benefit pensions.
The k plan has a reasonably short history yet it has already changed the face of retirement planning in America.
The k provision was created in as part of that year's Tax Revenue Act, but went largely unnoticed for two years until Ted Benna, a Pennsylvania benefits consultant, devised a creative and rewarding application of the law. Section k stipulated that cash or deferred-bonus plans qualified for tax deferral. Most observers of tax law had assumed that contributions to such plans could be made only after income tax was withheld, but Benna noticed that the clause did not preclude pre-tax salary reduction programs.
Benna came up with his innovative interpretation of the k provision in in response to a client's proposal to transfer a cash-bonus plan to a tax-deferred profit-sharing plan. The now-familiar features he sought were an audit-inducing combination then--pre-tax salary reduction, company matches, and employee contributions. Benna called his interpretation of the k rule "Cash-Op," and even tried to patent it, but most clients were wary of the plan, fearing that once the government realized its tax revenue-reducing implications, legislators would pull the plug on it.
Luckily for Benna and the millions of participants who have since utilized his idea, the concept of employee savings was gaining political ascendancy at that time. Ronald Reagan had made personal saving through tax-deferred individual retirement accounts, or IRAs, a component of his campaign and presidency.
Payroll deductions for IRAs were allowed in and Benna hoped to extend that feature to his new plan. He established a salary-reducing k plan even before the Internal Revenue Service had finished writing the regulations that would govern it. The government agency surprised many observers when it provisionally approved the plan in spring and specifically sanctioned Benna's interpretation of the law that fall. From to , the number of plans increased more than percent, and the rate of participation grew from 62 percent to 72 percent.
The number of employees able to participate in k plans rose to more than 48 million by from only 7 million in , and Benna's breakthrough earned him the appellation "the grandfather of k s. The advent of k plans helped effect a philosophical shift among employers, from the provision of defined-benefit pension plans for employees to the administration of defined-contribution retirement plans. In the past, companies had offered true pension plans that guaranteed all individuals a predetermined retirement benefit.
But after , rather than providing an employer-funded pension, many companies began to give employees the opportunity to save for their own retirement through a cash or deferred arrangement such as a k. This change helped level the playing field for small businesses, which were now able to offer the same type of retirement benefits as many larger employers. Small businesses thus found themselves better able to attract and retained qualified employees who may previously have opted for the security of a large company and its pension plan.
In benefits parlance, employers offering k s are sometimes called "plan sponsors" and employees are often known as "plan participants.
ERTA expanded upon and refined the Employee Retirement Income Security Act of ERISA , which had been enacted to protect participants and beneficiaries from abusive employer practices and created guidelines that were intended to ensure adequate funding of retirement benefits and minimum standards for pension plans.
Develop and improve products. List of Partners vendors. As the most widely used and well-known retirement savings plans in the United States, k plans were the brainchild of benefits consultant Ted Benna. In , Benna noticed that the rules established in the Revenue Act of made it possible for employers to establish simple, tax-advantaged savings accounts for their employees.
The term " k " refers to Section k of the Internal Revenue Code. The provision allows employees to avoid taxation on parts of their income if they elect to receive it as deferred compensation rather than as direct pay. Benna designed the k plan for a bank client seeking to give employees additional retirement benefits. However, the bank rejected the idea because it had never been done before, so Benna offered the first k plan to his own employees at The Johnson Companies. By the next year, several large companies began to offer new k plans to employees.
Participants in k plans could then use their deferred income to make investments without being taxed on gains. These new accounts quickly became popular. In , 7. In , Congress passed the Economic Growth and Tax Relief Reconciliation Act , which enabled catch-up contributions for participants age 50 and older. The act also allowed companies to offer Roth k accounts, which require post-tax contributions but provide the benefit of tax-free growth and distribution.
Modern k plans were not an intentional design of the U. Indeed, the U. Treasury Department under Ronald Reagan proposed killing the k in Employees receive two significant benefits from k plans and other tax-exempt retirement accounts: first, there is the obvious tax benefit.
On the downside, k plans are riskier for employees than defined benefits plans, which are federally guaranteed. There are obvious benefits to employers as well. For instance, the costs of offering retirement benefits have declined significantly. Small businesses particularly benefit from the new defined contribution plans. The plan allows these businesses to offer similar benefits packages to employees as those found in larger companies, leveling the playing field.
The federal government encourages the use of k s and other retirement plans. Even though tax receipts decline as more people participate, a population that funds its own retirement ends up reducing government expenditures on welfare programs for the elderly.
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