The Accidental Birth of the 401k

If you think the 401(k) was carefully designed by a panel of experts to solve America’s retirement crisis… think again.

In this episode, we dive into the completely accidental origin of the 401(k) — and how a small, technical provision buried inside the Revenue Act of 1978 quietly reshaped the entire retirement system in the United States.

By the 1970s, traditional pensions were already under pressure. Companies were struggling with rising costs, workers were changing jobs more frequently, and the math that once made pensions work was starting to fall apart. Something had to change.

But the solution didn’t come from a grand government task force or a sweeping retirement reform bill.

It came from one man — Ted Bena — who read a section of tax law meant for executive compensation and realized it could apply to everyday workers. Three years later, the IRS made it official. And just like that, the modern 401(k) was born.

Today, more than $14 trillion sits inside 401(k) plans.

And it all started with an interpretation.

Understanding that history matters. Because when you realize the 401(k) wasn’t designed to be the “perfect” retirement system — it changes how you think about relying on it.

Next episode: Why the 401(k) took off like wildfire… and how it became the backbone of retirement in America.

Chapters:
00:00:00 – Retirement Is Newer Than You Think
00:00:12 – From Pensions to Pressure: Why the Old System Started Cracking
00:02:30 – When the Pension Pyramid Turned Upside Down
00:04:41 – The Tiny Tax Rule That Changed Retirement Forever
00:06:29 – Ted Bena’s Interpretation… and the IRS Moment That Made It Real
00:07:49 – The $14 Trillion Accident That Became America’s Retirement Plan

Transcript

This week, I'm continuing my conversation from last week in which I talked about the history of retirement. In this episode, I'm going to discuss how the 401(k) came to be. Retirement in the United States is only about 100 years old, and it really developed quickly because of changing dynamics. All of a sudden, people were living longer, and then you had the Industrial Revolution, which really changed the economy in the United States. You had a manufacturing-focused economy in which you needed a much larger base of younger workers. You needed to force out the older workers so that the younger workers could come in, but what was going to happen with all of those older workers that now did not have employment? Well, the US government started the Social Security System in the 1930s, so that was the first public pension here in the United States. Then companies realized that this was a great way to retain good workers over a long stretch, offer them a pension plan. Say, "Hey, come work for us. Spend a long time here, and then you'll never have to worry again. Once you retire, we will take care of you for the rest of your life. We'll send you a check every month that enables you to maintain your existing lifestyle." For about 30 or 40 years, this system worked out great. Many people did work for the same company for 30, 40 years. It was a point of pride for many people during that time. They did their time at GM for a good example, and they spent all their time working there, and then afterwards, the company took care of them. And again, I think we started to take for granted this idea that all of a sudden we had retirement figured out. The pension system was working great. I think we've got this whole thing down. Yeah, retirement is going to continue, and this is how things are going to be for a long time. Remember what I said, retirement as a concept is a brand new thing. When was the last time something brand new came along and it was perfect in its first iteration? Probably nothing. I mean, especially now, you see new products all the time, and then they're always getting enhanced and changed and upgraded over time. So if we're looking at an overall system as big as retirement, of course it wasn't going to be done perfectly the first time around. By the 1970s, the traditional pension system was starting to show cracks because I've said it before, and I'll continue to say it again, pensions are expensive, and they are administratively burdensome. And economics at this time were starting to change. The United States was shifting from a manufacturing-based economy to a service-based economy. And all of a sudden you had people who weren't spending 30, 40 years at the same company, say on the manufacturing line. No, they were jumping around, and you also had more people in office roles than you did in manufacturing. So all of this was reshaping the pyramid that is necessary to keep pension plans afloat. To give you just a quick visualization, let's take your traditional pension plan, say in the 1940s, you had a large base of younger folks in the manufacturing company who were paying into the system, but you didn't have nearly as many folks who were retired and drawing from that system. Well, all of a sudden, the shape is starting to form more of a rectangle. You had the same number of people working for the company, but you had a growing number of people collecting benefits because retirees, again, were living longer, and you had fewer people paying in to help keep the pension system afloat. And then before you know it, you might even have an inverted triangle where you're paying more people out in the pension system than you have working for you. So all of a sudden, the writing is on the wall that pensions aren't working here. There's a reckoning that is very near on the horizon. Many companies are starting to ask, "Well, what are we going to do?" Now, I could sit here and tell you that

a perfect solution was very quickly on the horizon, and it was all thanks to a task force of government officials, academics, and business leaders who put together this grand new idea that saved the pension system in the United States.

That's not at all what happened, not even close. In fact, the answer to help solve the current pension crisis at the time in the United States came entirely by mistake.(...) So in order to answer what exactly came around, we have to look at what the landscape was in the 1970s. The US economy at that time was struggling. We had high unemployment. We had high interest rates. You had the energy crisis at that time. So the government was doing different things to try and stimulate the economy. And one of the things that they did was they passed the Revenue Act of 1978. Now, 99% of what's in that bill is completely irrelevant to this conversation. Only about 1% is relevant. And it was a small section in that Revenue Act called Section 401(k). And the original language of Section 401(k) was really a technical tax rule. It definitely was not the basis of this huge retirement framework. No, at the time, many business executives or higher ups in companies were trying to find ways to shelter income, especially deferred compensation or profit sharing income at a time when the highest marginal tax rate was as high as 70%.

(...)

So Section 401(k) was trying to clarify how bonuses and profit sharing could be deferred for tax purposes. And like I said, it was meant mostly for executives, those higher earners who didn't want to pay a 70% marginal tax rate. But one man, one single man saw an opportunity in the language. His name was Ted Bennett. Now, Ted still alive, so not was, is Ted Bennett. God bless Ted. He read the tax law and he interpreted the language in there to mean employees could start to defer part of their salaries into a tax deferred account. And boom, just like that, the modern 401(k) plan was born. Now, of course, it took three years for the IRS to issue formal guidance on this interpretation. Ted was the first one to create a 401(k) plan. He did it for his own company at the time. And three years later, the IRS issued the formal guidance that said, yes,(...) salary deferrals are allowed under Section 401(k). Now, I think it would have been funny if they had come back and said, no, no, no, you can't do that. I wonder what would have happened. But I'm guessing the IRS saw the writing on the wall that pension plans were facing issues. The retirement system in the United States needed some serious help.(...) And thanks to Bennett's interpretation and the introduction of a few of the first 401(k) plans, the IRS probably said, okay, yeah, this makes sense. Let's go ahead and do this. The important thing that I want people to remember from all of this is that the 401(k) was created entirely by accident. And it was based on one person's interpretation of a completely unrelated law at the time. The Revenue Act of 1978 was not meant to address retirement plans here in the US. There was one very small section that someone said, huh, there's an opportunity here. And just like that, the 401(k) was born. There was no government task force. There was no conference of very smart people who sat down and were trying to solve the looming retirement crisis. It was one single person's interpretation of an unrelated tax law. And yet the 401(k) has all of a sudden become the backbone of retirement in the United States. As of 2025, 401(k) plans have $14 trillion in assets in them. Now, I will continue to talk about the 401(k). And many times I'm going to talk about how powerful it is and the things that it does do right. But I think it's very important for everybody to understand its accidental nature. They need to know that because again, we take for granted in this day and age when things move so quickly, that something that doesn't change as quickly, like the 401(k), for example, that, well, this is it. This is always what's been and this is what always will be. Now, the 401(k) and the grand scheme of history is a very, very new thing. And who knows if it will continue to be the thing down the road. But people need to remember that just 50 years ago, we thought that the pension system was the thing for retirement and that our companies that we worked for were going to take care of us. And no, of course not. Things change. And so the 401(k) was the new thing that came around for retirement. Now, I think that the dynamics of the world will continue to change. And all of a sudden, perhaps the 401(k) may not be the thing for retirement. But right now it is. Again, I'm just trying to reiterate that people need to understand it is not, it has not been around forever and it may not be around forever. And because of its accidental nature, it should not be viewed as the end all be all for retirement. It does a lot of things well. And for many people, it will be enough to give them a good nest egg in retirement. But because of a lot of its drawbacks, people need to understand that the 401(k) by itself may not be enough. And again, when I talk about all this, I think it's very important to understand the history and how things came to be. Because like I said, you need to know where you've been until you before you can know where you are going. So next week, I am going to talk about how the 401(k) did catch on like wildfire and how it's become the backbone of retirement here in the US. But I thought it was very worthwhile to sit down and discuss how the Revenue Act of 1978 and one person's interpretation of a tax law accidentally created what is now known as the biggest retirement plan here in the United States. So hopefully that was eye opening for you. And I will see you next week when I talk about why the 401(k) took hold and became the backbone of retirement here in the US. Thanks.