The Vanishing Retirement Plan

Today in the United States, the majority of people who have pension plans have what is called a defined-contribution plan, like a 401(k).  In such a plan, what is defined is how much goes into the plan, not how much comes out of it. With a plan like this, you (and possibly your employer as well) pay a part of your salary into the plan. That amount is then invested on your behalf. The amount you can eventually draw out of the plan is just what was put into it, plus any investment earnings. There are no guarantees of any kind on this type of plan as to the amount of future benefits (if any).

The term defined contribution is to distinguish these plans from the other main type, which is the defined benefit plan. In that type, what is defined is what is paid out of the plan to you, rather than what is put in by you. Such plans pay out a defined amount, often based on a percentage of your final salary, usually for life.

Defined benefit plans once were common. Now most have disappeared, and been replaced by defined contribution plans (which barely existed at all before 1978), as employers have successfully sought to transfer the risk of future pension costs from themselves to their employees. The main exceptions are public employee pension plans, which are still largely defined-benefit plans.

With the now-more-common defined contribution plan, you must do everything you can to make the best of the investment choices that are offered to you. That will be the subject of future articles. For today, here is a quick thumbnail history of retirement plans in the U.S. Much of this information comes from a study called A Timeline of the Evolution of Retirement In the United States, by the Georgetown University Law Center.

In 1875, the American Express Company established the first private pension plan in the United States “in an effort to create a stable, career oriented workforce.”

By 1900, there were still only 13 private pension plans in the country. Roughly 75 percent of all males over age 65 were working. If a male over age 65 was not working, it was likely because he was disabled.

In 1913 the first federal income tax law was enacted. The following year, the new IRS ruled that pensions paid to retired employees were deductible, similar to wages, as ordinary and necessary business expenses.

In 1919, after World War I, over 300 private pension plans existed, covering approximately 15 percent of the nation’s wage and salary employees. Competition for workers during the war had led to employers’ desire to attract workers, reduce labor turnover, and “more [humanely] remove older, less productive employees.”

In 1935, Social Security was enacted, establishing age 65 as the normal retirement age. Life expectancy was about 60 years at birth. Those who reached the age of 65 could expect to live, on average, another 12 years.

In 1942, at the beginning of World War II, the Wage and Salary Act of 1942 froze wages in an attempt to contain wartime inflation. The wage freeze did not apply to fringe benefits. The freeze on wages but not benefits, along with increased corporate income tax rates, encouraged employers to offer pension, health and welfare benefits as alternative means to attract workers while reducing their taxes.

In 1950 9.8 million private-sector workers (25 percent of all private sector workers) were covered by a pension plan. By 1970 this increased to 26.3 million (45 percent of all private-sector workers).

In 1978, section 401(k) of the Internal Revenue Code established the blueprint for defined contribution plans going forward.

In 1980, 35.9 million private-sector workers (46 percent of all private-sector workers) were covered by a pension plan. Almost all of these were still defined-benefit plans.

In the early 1980’s it became obvious that with shifting demographics (the end of the Baby Boom and longer lifespans), defined benefit plans including Social Security itself were not sustainable in the long run without significant changes. Various tax increases and benefit cuts were made to shore up Social Security for the time being. Corporations began aggressively switching from defined benefit to defined contribution plans.

By 1999 about 100 million Americans in the private sector were covered by pension plans, about 40% in defined benefit plans and 60% in defined contribution plans.

In 2006 about 63% of all private sector workers were covered, a little over two-thirds of those by defined contributions plans.

Since 2006 many employees, notably including union workers in the auto and airline industries, and even some public employees, have had their defined benefit plans terminated or greatly reduced. Virtually no new defined benefit plans have been created in recent years.

So much for the history lesson. What it means to you is that, unless you are independently wealthy or are one of the fortunate few still collecting a pension from a defined benefit plan, providing for your retirement is up to you. You are in charge of growing and protecting the capital you will need for a secure retirement.

Our Proactive Investor program is designed to help with this crucial process. Whether your retirement assets are in a 401(k), elsewhere, or even if they are just a gleam in your eye so far, we can help you to build wealth for the long term. If you haven’t looked into this program yet, you owe it to your future happily retired self to check it out.

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