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(Bloomberg Opinion) –The 401(k) retirement plan was authorized by the Revenue Act of 1978, which took effect in 1980, but its real genesis is the 1974 Employee Retirement Income Security Act, which fixed the problem of underfunded defined-benefit plans so thoroughly that private employers stopped offering them. Benefits consultant Ted Benna came up with a way to use the 1978 Act for a tax-deferred, defined-contribution plan and the rest is history.
The tax advantage of a 401(k) depends on four factors, all of which have changed dramatically since 1980 to the detriment of 401(k)s. For a median-income married couple with two children:
- The marginal federal income tax rate was 43% in 1980, 12% today
- The capital gains tax rate was 28% in 1980, 0% today*
- The likely retirement bracket tax rate was 15% in 1980, 12% today
- Interest rates in 1980 were around 15%, compared to 0% today
Making some reasonable assumptions about a worker with 30 years to retirement, the 1980 version of the 401(k) tax deferral was equivalent to an additional investment return of 9.2% per year, an extraordinary incentive to save for retirement, even without an employer match.
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