401(k) Plans
Section 401(k) of the Internal Revenue Code, as amended, was added to the tax code in the Revenue Act of 1978. The key issue under this code section was the simple provision to allow employees to contribute pre-tax towards their retirement. Proposed Treasury regulation issued in 1981 gave some semblance of a roadmap on how to run these plans, with the original provisions allowing deferrals of up to $30,000/yr, only shortly to be reduced under Reagan and a democratic Congress to $7,000/yr.
This code section created an attachment to an existing or new profit-sharing plan. Because many 401(k) early adopters only provided a token matching contribution for employees of 0.25% of pay to 6% of pay, these plans often shifted from old conventional employer paid profit-sharing only plans to deferral and match 401(k) plans with little or no profit-sharing.
Most plan sponsors and employee participants were disadvantaged from inception with these plans as Congress and the regulators, primarily the Department of Labor, had prohibitions on the rendering of investment advice to participants; in fact, it was a prohibited transaction, subject potentially to civil and even criminal liability. Participant education and investment information was limited to giving a participant enough information to make an informed decision.
In the ‘90’s, employers were given a safe harbor from liability by adopting Erisa section 404(c) in the rendering of educational and investment information but advice was still prohibited.
In 2006, the passage of the Pension Protection Act of 2006 changed the 25 year prohibition on allowing advice to participants for the first time, and also introduced a means for plan sponsors to offer advice options without legal liability.
Regulations come and go over the years but the basic essence of code section 401(k) is still intact: elective deferrals, now either pre-tax or, after-tax (Roth deferrals), allow contributions of $16,500/yr. in 2011, with an additional $5,500 catch-up deferral to total $22,000 if the participant is age 50 or over in 2011.
The technology revolution of the ‘90’s changed the record keeping and administration landscape to the extent that daily valuation for participants in all size plans has become the norm, with on-line web access 24/7 to view accounts, and trade the account any day the stock and bond market is open.
Participants can print statements on demand, have access to unlimited investment alternatives, advice tools and even human personal investment advice in many cases.
The creative destruction brought by technological advances has forced fees to manage 401(k) plans from a standard of 3% of assets or more in the 1980’s to less than 1% today in many cases. These higher range of fees primarily existed amongst small plans, defined by the IRS as those having fewer than 100 participants and not subject to an annual audit.
The emphasis in 401(k) plans is shifting from benefits and features to getting participants the advice they need and focusing on retirement preparedness and the corresponding income stream their account balances can provide, in some cases, with a guarantee.
For more information, please contact Greg.Rhinehardt@gamria.com
