What Laws Govern 401(k)s?

A 401(k) plan is a retirement savings plan many American employers offer. An employee who signs up for a 401(k) agrees to have a pretax percentage of each paycheck deducted and invested directly into a managed retirement account, and their employer may match part or all of that contribution up to a certain percentage. The employee gets to choose from among a number of investment options, usually mutual funds, and they come with tax advantages for the saver.

401(k) plans are regulated by a variety of federal and state regulations that affect everything from the way they are administered to the way they are advertised. These plans are named after a section of the U.S. Internal Revenue Code. However, the rights of consumers with regard to 401(k) plans are more heavily dependent on two key pieces of legislation—the Employee Retirement Income Security Act (ERISA) and the Setting Every Community Up for Retirement Enhancement Act (SECURE). 

In this guide, we’ll briefly look at each piece of legislation and how it affects 401(k) accounts.

The Early Days

The first 401(k) plans date back to when Congress passed the Revenue Act of 1978. This act included a provision—named after the Internal Revenue Code Section 401(k)—that gave employees a tax-free way to defer compensation from bonuses or stock options. The law went into effect on Jan. 1, 1980. It wasn’t until the following year, however, that the IRS issued rules that allowed employees to contribute to their 401(k) plans through salary deductions. This provision jump-started the widespread rollout of 401(k) plans in the early 1980s and has been largely responsible for their widespread adoption today.

It’s worth noting that the 401(k) was never really designed to be a catch-all solution for retirement. At the time that the 401(k) was first formulated, many employees were offered defined-benefit retirement plans, which many analysts argue are better for employees and employers alike. According to a 2021 report by the Congressional Report Service, only 15% of private sector employees have access to a pension plan compared to 68% of state and local public sector employees. In the same year, the Pension Rights Center reported that 30% of older Americans have a pension.

The Employee Retirement Income Security Act (ERISA)

Another unusual aspect of 401(k) plans is that many of their major provisions are regulated by a law that came into effect before the 401(k) provision existed—the ERISA Act of 1974. 

ERISA is a federal law that protects the retirement assets of American workers. The law implemented rules that qualified plans must follow to ensure that plan fiduciaries do not misuse plan assets. At the time the act was passed, the majority of retirement accounts were defined-benefit accounts and not 401(k) accounts; however, the act now covers a huge variety of retirement vehicles, including 401(k) plans.

ERISA states that the administrators of 401(k) plans must regularly inform participants about their features and funding. It also sets minimum standards for participation, vesting, benefit accrual, and funding and defines how long a person may be required to work before they're eligible to participate in a plan, accumulate benefits, and have a non-forfeitable right to those benefits. It also grants retirement plan participants the right to sue for benefits and breaches of fiduciary duty. ERISA is enforced by the Employee Benefits Security Administration (EBSA), a unit of the Department of Labor (DOL).

The SECURE Act

The next major update to the way that 401(k) plans work came with the Setting Every Community Up for Retirement Enhancement Act of 2019, better known as the SECURE Act. 

This act contained many provisions that have subtly altered the way in which 401(k) plans work, many of which had been under discussion for years. John Lowell, an Atlanta-based actuary, and advisor with October Three Consulting told the Society for Human Resource Management in 2020 that "to a large extent, the SECURE Act is a hodgepodge of a lot of little retirement policy initiatives,” but which greatly alter how employers provide retirement savings plans.

The act came in response to a perceived crisis in the U.S. retirement system. According to data from the U.S. Bureau of Labor Statistics published in March 2019, only 56% of the civilian adult population participated in a workplace retirement plan.

In response, the SECURE Act aimed to make it easier for small employers to set up 401(k)s by increasing the cap under which they can automatically enroll workers in “safe harbor” retirement plans from 10% of wages to 15%. It also:

• Provides a maximum tax credit of $500 per year to employers who create a 401(k) or SIMPLE IRA plan with automatic enrollment. 
• Enables businesses to sign up part-time employees who work either 1,000 hours throughout the year or have three consecutive years with 500 hours of service. 
• Encourages plan sponsors to include annuities as an option in workplace plans by reducing their liability if the insurer cannot meet its financial obligations. 
• Pushes back the age at which retirement plan participants need to take required minimum distributions (RMDs) from 72 to 73 for account owners born between 1951 and 1959 and 75 for those born in 1960 or later. 
• Allows the use of tax-advantaged 529 accounts for qualified student loan repayments (up to $10,000 annually). 
• Permits penalty-free withdrawals of $5,000 from 401(k) accounts to defray the costs of having or adopting a child. 
• Encourages employers to include more annuities in 401(k) plans by removing their fear of legal liability if the annuity provider fails to provide, and also not requiring them to choose the lowest-cost plan. (This could be something of a double-edged sword. Employees will need to look at these options extra carefully.)

Overall, this was the most extensive overhaul of the 401(k) provisions since their inception in 1980. Americans’ reliance on 401(k) accounts as a primary retirement vehicle has continued to increase as a result.

The Bottom Line

There is a significant range of laws and regulations that apply to 401(k) accounts. These accounts are named after a section of the U.S. Internal Revenue Code and were first offered in 1980. ERISA was passed in 1974 and provides rights to consumers whose assets are invested in retirement accounts, including 401(k) accounts. SECURE, passed in 2019, aimed to make 401(k) accounts more flexible and encourage both employers and employees to sign up for them. Though the 401(k) account was never intended to replace defined benefit plans, most employers have phased out pensions and shifted the burden of retirement savings onto employees.