Why do money and trading exist? – Vanessa C., age 10, Gilbert, Arizona
Imagine a world without money. With no way to buy stuff, you might need to produce everything you wear, eat or use unless you could figure out how to swap some of the things you made for other items.
Just making a chicken sandwich would require spending months raising hens and growing your own lettuce and tomatoes. You’d need to collect your own seawater to make salt.
You wouldn’t just have to bake the bread for your sandwich. You’d need to grow the wheat, mill it into flour and figure out how to make the dough rise without store-bought yeast or baking powder.
And you might have to build your own oven, perhaps fueled by wood you chopped yourself after felling some trees. If that oven broke, you’d probably need to fix it or build another one yourself.
Even if you share the burden of getting all this done with members of your family, it would be impossible for a single family to internally produce all the goods and provide all the services everyone is used to enjoying.
To maintain anything like today’s standard of living, your family would need to include a farmer, a doctor and a teacher. And that’s just a start.
Specializing and bartering
Economists like me believe that using money makes it a lot easier for everyone to specialize, focusing their work on a specific activity.
A farmer is better at farming than you are, and a baker is probably better at baking. When they earn money, they can pay others for the things they don’t produce or do.
As economists have known since David Ricardo’s work in the 19th century, there are gains for everyone from exchanging goods and services – even when you end up paying someone who is less skilled than you. By making these exchanges easy to do, money makes it possible to consume more.
People have traded goods and services with one kind of money or another, whether it was trinkets, shells, coins and paper cash, for tens of thousands of years.
People have always obtained things without money too, usually through barter. It involves swapping something, such as a cookie or a massage, for something else – like a pencil or a haircut.
Bartering sounds convenient. It can be fun if you enjoy haggling. But it’s hard to pull off.
Let’s say you’re a carpenter who makes chairs and you want an apple. You would probably find it impossible to buy one because a chair would be so much more valuable than that single piece of fruit. And just imagine what a hassle it would be to haul several of the chairs you’ve made to the shopping mall in the hopes of cutting great deals through barter with the vendors you’d find there.
Paper money is far easier to carry. You might be able sell a chair for, say, $50. You could take that $50 bill to a supermarket, buy two pounds of apples for $5 and keep the $45 in change to spend on other stuff later. Another advantage money has over bartering is that you can use it more easily to store your wealth and spend it later. Stashing six $50 bills takes up less room than storing six unsold chairs.
Nowadays, of course, many people pay for things without cash or coins. Instead, they use credit cards or make online purchases. Others simply wave a smartwatch at a designated device. Others use bitcoins and other cryptocurrencies. But all of these are just different forms of money that don’t require paper.
No matter what form it takes, money ultimately helps make the trading of goods and services go more smoothly for everyone involved.
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M. Saif Mehkari does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.
Americans held $7.3 trillion in 401(k) plans as of June 30, 2021, according to the Investment Company Institute. And the typical wealth held in an American family's 401(k) has more than tripled since the late 1980s. With the widespread adoption of 401(k) plans, it might surprise you that they're a relatively new employee benefit—and one that was created unintentionally by lawmakers.
Today, public and private sector employees alike use a 401(k)—or the nonprofit equivalent, a 403(b)—in order to plan for a comfortable retirement. In essence, a 401(k) allows an employee to forgo receiving a portion of their income, instead steering it into an account where the money can grow through investments. Unlike pensions, these retirement plans put more of the planning decisions—and responsibility—on employees rather than the company.
Employers can contribute to an employee's retirement savings by matching the contributions to a 401(k) account up to an amount decided by the employer.
"The savings comes off the top, so a lot of people don't miss their money when it's going into their 401(k)," Ted Benna, the man long-credited for introducing the 401(k) to corporate America, told Forbes in 2021.
Whether or not that savings that "comes off the top" yields small or large returns is influenced by the employee's age, tolerance for risk as well as market conditions over the lifetime of the account.
Before the mighty 401(k) there were Cash or Deferred Arrangements, commonly known as CODAs.
These arrangements between companies and workers allowed employees to defer some of their income and the taxes they paid on it for a period of time. CODAs were a funding mechanism for stock bonus, pension, and profit-sharing plans.
In 1974, the Employee Retirement Income Security Act (ERISA) was enacted, creating a governmental body that oversaw and regulated company-sponsored retirement and health care plans for workers.
ERISA temporarily halted IRS plans to severely restrict retirement plans through regulation in the early 1970s, according to the EBRI. The act created a study of employee salary reduction plans as well, which the EBRI credits for influencing the creation of the 401(k) later on in the decade.
Harold M. Lambert // Getty Images
The modern 401(k) originated in earnest in 1978 with a provision in The Revenue Act of 1978 which said that employees can choose to receive a portion of income as deferred compensation, and created tax structures around it.
Section 401 was originally intended by lawmakers to limit companies creating tax-advantaged profit-sharing plans that mostly benefited executives, according to the ICI. Thanks to the interpretation of the section by businessman Ted Benna, the language evolved into the basis of the modern 401(k), as it enabled profit-sharing plans to adopt CODAs.
The law was signed by President Jimmy Carter and became effective at the turn of the decade. Regulations were then created and issued by the end of 1981.
The Revenue Act of 1978 not only created the foundation for 401(k) savings plans but also flexible spending accounts for medical expenses and the independent contractor classification as it pertains to how a company pays employment taxes.
Nicholas Hunt // Getty Images
Ted Benna, pictured above, is popularly known as the "Father of the 401(k)" for his work advocating for companies to adopt plans in accordance with the IRS' new Revenue Act of 1978.
His self-described "aggressive" interpretation of the eponymous 401(k) section within the Act led him to create the first-ever 401(k) savings plan in the U.S. for his consulting company.
Through business connections, Benna was introduced to Treasury officials and provided recommendations as to how 401(k) should be regulated. Ultimately, Benna was able to help steer the success and adoption of the nascent retirement tool.
Today, Benna advocates for laws that would require employers to auto-enroll their workers in 401(k) plans, meaning employers would automatically deduct payroll deferrals unless an employee elects not to participate. One of the biggest downsides to 401(k) plans is actually that more workers don't utilize them sooner in their careers. The earlier a person starts contributing money to one of these retirement accounts, the better positioned they are to significantly grow funds by their target retirement age.
While 68% of private sector American workers had access to employee-sponsored retirement plans in 2021, only about half of all Americans took advantage of one.
Barbara Alper // Getty Images
In the late 1970s, pioneering aviation company Hughes Aircraft was well on its way to becoming the largest industrial employer in the state of California. The company's outside legal consultant Ethan Lipsig was writing letters to Hughes Aircraft, encouraging the company to turn the savings plan it offered employees into a 401(k) plan.
But it wasn't until the IRS issued regulations assuring employers that they could legally defer a portion of payroll compensation to a 401(k) savings account that companies like Hughes, J.C. Penney, Johnson & Johnson, and PepsiCo began offering the plans to workers.
Nearly half of all large employers in the U.S. were offering 401(k) plans to their workers by the end of 1982.
MPI // Getty Images
In 1984 and again in 1986 U.S. lawmakers, pictured above, made amendments to the country's tax code sometimes referred to today as the "Reagan tax cuts."
In 1984, laws were amended as part of the so-called Deficit Reduction Act to tighten the rules around deferred compensation, including 401(k) savings plans. The legislation ensured that less highly compensated employees could also benefit from plans—not just the highest paid workers. In a brief published in September 1985, the EBRI expressed concern that Reagan's amendment could jeopardize the popularity of 401(k) savings plans.
The Tax Reform Act of 1986 consolidated tax brackets, lowered federal income taxes, and placed an annual limit on deferred compensation, according to the EBRI. It had the added benefit of "endorsing" the 401(k) as a legitimate retirement vehicle because the Act implemented a 401(k)-type plan for federal employees.
David Hume Kennerly // Getty Images
The Small Business Job Protection Act came along in 1996 and simplified retirement programs—called SIMPLE plans—for small businesses. The act signed into law by President Bill Clinton was intended to help make America's small businesses more competitive with large firms.
It specifically made the employer-matching contribution process easier through SIMPLE plans for businesses with fewer than 100 employees. The act also lowered taxes for small businesses, created safe-harbor formulas to eliminate the need for nondiscrimination testing, simplified pensions, and raised the minimum wage.
Officially launched to the public in 2006, a Roth 401(k) is employer-sponsored like a traditional 401(k). The account holder elects to contribute a portion of their income to the account, and the employer has the option to contribute matching funds.
The difference is that contributions are taxed before they go into the Roth account, which means that the owner doesn't have to pay taxes again when they withdraw from the account after they are aged 59 and a half or older. At its core, the Roth 401(k) gives the owner the advantage of paying taxes now instead of being taxed on withdrawals later in life when the account is worth more monetarily—or when future tax rates may have increased.
Millennials are more likely to contribute to Roth 401(k)s than older generations, according to a 2019 report from the Transamerica Center for Retirement Studies.
Tom Williams // Getty Images
Flash forward to the current day and much has changed about planning for retirement. Pensions have all but disappeared and many Americans continue to redefine what retirement will look like for them — and how to plan ahead for it. In the U.S., people live on average 10 years longer today than they did when the 401(k) was created in 1978, and recent research suggests that generations younger than baby boomers may live longer than their retirement accounts will support them. So it's more important than ever that people stay on top of changes in their retirement planning. As more tools, technology, and resources became available for learning and investing, legislation has also been introduced to help Americans navigate retirement decisions.
The Senate is currently debating a set of bills collectively referred to as "SECURE 2.0," as they build on the SECURE Act passed in 2019. Among other changes, the 2019 legislation made it so part-time workers could participate in retirement plans and made offering plans more appealing for small businesses that may have been hesitant in the past.
SECURE 2.0 goes further to make employee enrollment in a retirement savings plan like a 401(k) mandatory. It would also alter rules around making late contributions to payments so that Americans older than 50 can contribute even more than previously to their accounts.
This story originally appeared on Guideline and was produced and distributed in partnership with Stacker Studio.
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