The History of Wealth: ERISA and 401(k)s.
Most Americans don’t know their retirement plan started as a corporate tax loophole which “mistakenly” created the American retirement system we know today. In 1974, Congress passed the Employee Retirement Income Security Act (ERISA) to protect worker pensions after many fund collapses. The law set strict standards for pension management through fiduciary duty and created the Pension Benefit Guaranty Corporation to insure benefits, and backstop collapses. While it was intended to help workers and secure their retirement benefits ultimately it is attributed to creating the destruction of the Defined Benefit system.
Before ERISA, private-sector pensions were predominantly defined-benefit plans. Your employer promised you a specific monthly payment in retirement at a specific percentage of your final salary or highest earning year. The companies managed the investments, shouldered the risk, and guaranteed payout. In 1975, 70% of retirement plan participants had a pension that guaranteed lifetime income and in recent years that figure has dropped to below 13%. By imposing new regulations, setting funding requirements, shifting total risk to employers, and increasing reporting rules making it expensive to administer, companies started looking for alternative retirement plans.
About 4 years later, companies found an alternative to DB plans that would change the trajectory of American wealth creation, this was Section 401(k) of the Internal Revenue Code added in 1978. The provision was narrow and technical, it allowed employees to defer income taxes on bonuses by putting that money into retirement accounts, initially designed for executive compensation. Then in 1981, the IRS issued regulations clarifying that employers could allow employees to contribute their own salaries to these accounts and match contributions. A benefits consultant named Ted Benna saw the opportunity, companies could shift from these expensive pension plans to cheap 401(k) plans and transfer investment risk to employees. The shift happened fast and by 1998, these plans had overtaken pension plans in total participants. Today, most private-sector companies offer 401(k) or similar plans which has become an institutionalized piece of the US retirement system.
So, what changed? The responsibility for Americans shifted from one where the employer hired actuaries, managed the portfolio and promised employees income. But under the new system, you pick your own funds, bear the market risk, and hope you have enough saved when you retire. Companies got predictable, capped expenses and workers got “ownership” of accounts that they in turn must manage or hire another expert to manage for them.
ERISA was supposed to protect retirement security and the 401(k) was supposed to be a supplemental savings vehicle. But together they became the architecture of a system that transferred financial risk from institutions to individuals without most people voting for or realizing the trade they’d made.
Your 401(k) is not a benefit, but a responsibility with a tax incentive. If you are starting your career now, you’re entering a retirement system that was not designed to be anyone’s primary plan. The question is not whether you should participate, because you must, there is no defined benefit waiting for you. The question is whether you understand the system built on a loophole turned into a blueprint.
So, since the game has changed without asking you, all you can do is learn the new rules. That starts with understanding what you are investing in and how the system treats the wealth you are trying to build, and why it is harder to build wealth from income than from assets that you can own.