The Origins Of The Retirement Plan

Back during the Revolutionary War, the Continental Congress promised a monthly lifetime income to soldiers who fought and survived the conflict. This guaranteed income stream, called a "pension", was again offered to soldiers in the Civil War and every American war since.

Since then, similar pension promises funded from public coffers expanded to cover retirees from other branches of government. States and cities followed suit -- extending pensions to all sorts of municipal workers ranging from policemen to politicians, teachers to trash collectors.

A pension is what's referred to as a defined benefit plan. The payout promised a worker upon retirement is guaranteed up front according to a formula, typically dependent on salary size and years of employment.

Understandably, workers appreciated the security and dependability offered by pensions. So, as a means to attract skilled talent, the private sector started offering them, too.

The first corporate pension was offered by the American Express Company in 1875. By the 1960s, half of all employees in the private sector were covered by a pension plan.

Off-loading Of Retirement Risk By Corporations

Once pensions had become commonplace, they were much less effective as an incentive to lure top talent. They started to feel like burdensome cost centers to companies.

As America's corporations grew and their veteran employees started hitting retirement age, the amount of funding required to meet current and future pension funding obligations became huge. And it kept growing. Remember, the Baby Boomer generation, the largest ever by far in US history, was just entering the workforce by the 1960s.

Companies were eager to get this expanding liability off of their backs. And the more poorly-capitalized firms started defaulting on their pensions, stiffing those who had loyally worked for them.

So, it's little surprise that the 1970s and '80s saw the introduction of personal retirement savings plans. The Individual Retirement Arrangement (IRA) was formed by the Employee Retirement Income Security Act (ERISA) in 1974. And the first 401k plan was created in 1980.

These savings vehicles are defined contribution plans. The future payout of the plan is variable (i.e., unknown today), and will be largely a function of how much of their income the worker directs into the fund over their career, as well as the market return on the fund's investments.

Touted as a revolutionary improvement for the worker, these plans promised to give the individual power over his/her own financial destiny. No longer would it be dictated by their employer.

Your company doesn't offer a pension? No worries: open an IRA and create your own personal pension fund.

Want to retire sooner? Just increase the percent of your annual income contributions.

All this sounded pretty good to workers. But it sounded GREAT to their employers.

Why? Because it transferred the burden of retirement funding away from the company and onto its employees. It allowed for the removal of a massive and fast-growing liability off of the corporate balance sheet, and materially improved the outlook for future earnings and cash flow.

As you would expect given this, corporate America moved swiftly over the next several decades to cap pension participation and transition to defined contribution plans.

The table below shows how vigorously pensions (green) have disappeared since the introduction of IRAs and 401ks (red):

So, to recap: 40 years ago, a grand experiment was embarked upon. One that promised US workers: Using these new defined contribution vehicles, you'll be better off when you reach retirement age.

Which raises a simple but very important question: How have things worked out?

The Ugly Aftermath

America The Broke

Well, things haven't worked out too well.

Three decades later, what we're realizing is that this shift from dedicated-contribution pension plans to voluntary private savings was a grand experiment with no assurances. Corporations definitely benefited, as they could redeploy capital to expansion or bottom line profits. But employees? The data certainly seems to show that the experiment did not take human nature into account enough – specifically, the fact that just because people have the option to save money for later use doesn't mean that they actually will.

First off, not every American worker (by far) is offered a 401k or similar retirement plan through work. But of those that are, 21% choose not to participate (source).

As a result, 1 in 4 of those aged 45-64 and 22% of those 65+ have $0 in retirement savings (source). Forty-nine percent of American adults of all ages aren't saving anything for retirement.

In 2016, the Economic Policy Institute published an excellent chartbook titled The State Of American Retirement (for those inclined to review the full set of charts on their website, it's well worth the time). The EPI's main conclusion from their analysis is that the switchover of the US workforce from defined-benefit pension plans to self-directed retirement savings vehicles (e..g, 401Ks and IRAs) has resulted in a sizeable drop in retirement preparedness. Retirement wealth has not grown fast enough to keep pace with our aging population.

The stats illustrated by the EPI's charts are frightening on a mean, or average, level. For instance, for all workers 32-61, the average amount saved for retirement is less than $100,000. That's not much to live on in the last decades of your twilight years. And that average savings is actually lower than it was back in 2007, showing that households have still yet to fully recover the wealth lost during the Great Recession.

But mean numbers are skewed by the outliers. In this case, the multi-$million households are bringing up the average pretty dramatically, making things look better than they really are. It's when we look at the median figures that things get truly scary:

Nearly half of families have no retirement account savings at all. That makes median (50th percentile) values low for all age groups, ranging from $480 for families in their mid-30s to $17,000 for families approaching retirement in 2013. For most age groups, median account balances in 2013 were less than half their pre-recession peak and lower than at the start of the new millennium.

The 50th percentile household aged 56-61 has only $17,000 to retire on. That's dangerously close to the Federal poverty level income for a family of two for just a single year.

Most planners advise saving enough before retirement to maintain annual living expenses at about 70-80% of what they were during one's income-earning years. Medicare out-of-pocket costs alone are expected to be between $240,000 and $430,000 over retirement for a 65-year-old couple retiring today.

The gap between retirement savings and living costs in one's later years is pretty staggering:

Nearly 83% of retired households have less saved than Medicare costs alone will consume.

One-third of retired households are entirely dependent on Social Security. On average, that's only $1,230 per month – a hard income to live on. (source)

34 percent of older Americans depend on credit cards to pay for basic living expenses such as mortgage payments, groceries, and utilities. (source)

As for Medicare, the out-of-pocket costs could easily soar over retirement. The Wall Street Journal reports that the current estimate of Medicare's unfunded liability now tops $42 Trillion. Such a mind-boggling gap makes it highly likely that current retirees will not receive all of the entitlements they are being promised.

And the denial being shown by baby boomers entering retirement is frightening. Many simply plan to work longer before retiring, with a growing percentage saying they plan to work "forever".

Add to this the nefarious impact of the Federal Reserve's prolonged 0% interest rate policy, which has made it extremely hard for retirees with fixed-income investments to generate a meaningful income from them.

The number of Americans aged 65 years and older is projected to more than double in the next 40 years:

Will the remaining body of active workers be able to support this tsunami of underfunded seniors? Don't bet on it.

Especially since their retirement savings prospects are even more dim. With long-stagnant real wages and punishing price inflation in the cost of living, Generation X and Millennials are hard-pressed to put money away for their twilight years:

Public Pensions: Broken Promises

And for those "lucky" folks expecting to enjoy a public pension, there's a lot of uncertainty as to whether they're going to receive all they've been promised.

Due to underfunded contributions, years of portfolio under-performance due to the Federal Reserve's 0% interest rate policy, poor fund management, and other reasons, many of the federal and state pensions are woefully under-captialized. The below chart from former Dallas Fed advisor Danielle DiMartino-Booth shows how the total sum of unfunded public pension obligations exploded from $292 billion in 2007 to $1.9 trillion by the end of 2016:

And the daily headlines of failing state and local pension funds (Illinois, Kentucky, New Jersey, Dallas, Providence -- to name but a few) show that the problem is metastasizing across the nation at an accelerating rate.

Affording Your Future

The bottom line when it comes to retirement is that you're on your own. The vehicles and the promises you've been given are proving woefully insufficient to fund the "retirement" dream you've been sold your whole life.

That's the bad news.

But the good news is that the dream is still attainable. There are strategies and behaviors that, if adopted now, will make it much more likely for you to be able to afford to retire -- and in a way you can enjoy.

In Part 2: Success Strategies For Retirement, we detail out these best practices for a solvent retirement, including providing 14 specific action steps you can start taking right now in your life that will materially improve your odds of enjoying your later years with grace.

For far too many Americans, "retirement" will remain a perpetual myth. Don't let that happen to you.

Join the discussion

12 Comments

Scary stats, Adam. Thanks for continuing to bring attention to the importance of getting our financial house in order along with pursuing all the other forms of capital.

I'm not currently a paying member so this suggestion may be in part two but a good resource for those of us trying to be as frugal as we can is the site Mr. Money Moustache. I'd love to hear about other resources the rest of the PP community appreciates.

Living well while spending well beneath my means continues to be a challenging but satisfying endeavor. I only wish I would have taken it more seriously earlier in my life!

"Add to this the nefarious impact of the Federal Reserve's prolonged 0% interest rate policy,"

"Add to this the nefarious policy of the prolonged 0% interest rate by the Federal Reserve" represents reality. Why is everybody a coward when it comes to challenging the Status Quo? When you can't call a spade a spade for the danger it is when the danger is inevitable and life threatening, how can you expect to survive?

"Add to this the nefarious impact of the Federal Reserve's prolonged 0% interest rate policy,"

"Add to this the nefarious policy of the prolonged 0% interest rate by the Federal Reserve" represents reality. Why is everybody a coward when it comes to challenging the Status Quo? When you can't call a spade a spade for the danger it is when the danger is inevitable and life threatening, how can you expect to survive?

There's a whole subculture now available on the internet that lives in cars and vans. It's cheap, but it does present a number of obstacles. The biggest obstacles are crime and not being welcome by land owners, residents, businesses and therefore the police. As a result, there is an emphasis on hiding the fact that you're living out of the vehicle (stealth). These will get you started if you need to retire to a car or van.

I'm not familiar with Mr. Money Moustache. I'll have to look that site up.

The resource I found many years ago that help guide me to living a great life well below my means was the book "Your Money or Your Life" by Joe Dominguez and Vicki Robin. I highly recommend it, though not all parts of it are as relevant in today's world. I understand Vicki Robin (Joe died some time ago) may be working on a new book to bring everything up to date again. Still, even an old first edition copy of the book will have many resources to help individuals find personal fulfillment living below their means.

"Understandably, workers appreciated the security and dependability offered by pensions. So, as a means to attract skilled talent, the private sector started offering them, too."

Bullshit. Unions forced the issue.

Truth.

We tend to forget how many substantial and cherished improvements unions have brought about, mostly because many of us only know of unions in the era in which they were associated with organized crime, dirty communists, or recalcitrant and unreasonable workers’ demands. The degree to which TPTB try to discredit and downplay worker’s unions should in and of itself be proof of the good they can do for average Americans. It’s no coincidence that the gap between the wealthy and everyone else began widening right around the time Reagan began assaulting unions. As an ex-union rep for my local public school, I can attest that unions can sometimes get greedy, but the elite calling them out on that is like the pot calling the kettle black.

Historically, we also forget that it was precisely the threat of communism that forced the issue; the elite could either give in to piecemeal improvements demanded by unions, or face the wrath of a full-scale working class revolt. Why do you think England was the only industrialized nation that did not experience massive upheaval during the years 1848-49? They had been giving minor concessions to the working classes for over a decade.

Let's not forget that life expectancy was in the low 60s when many of these plans, union, public and private, were launched. Now someone can work 30 years, retire at 55 and live to 85--30 years of retirement instead of the expected 3 years. No pension plan can handle that unless the workforce contributing to the plan grows like Topsy, hence the coming bankruptcy of all defined-benefit plans as the size of the workforce isn't growing and neither are wages for the bottom 90%.

The main assumption of all defined-benefit plans is "growth"--more workers contributing, higher wages, higher profits, and so on. None of these defined-benefit plans can survive a massive decline in the working population whose contributions keep the plans solvent, and wages that are stagnant, not rising.

Lastly, we haven't been "growing"--we've been eating our seed corn. There is no way any defined-benefit plan can survive in an economy that is eating its seed corn.

I have many friends and family (including Canadians) who have been diagnosed with Parkinsons and cancer while in their 40's, 50's, and 60's. This is a small pool of geographically dispersed individuals. The Canadians, in particular, seem to be afflicted. We may not need to worry about the actuarial projections that there will be fewer and fewer working folks supporting retired boomers.

The General Accounting Office (GAO) of the US Government, in their rarely read annual Citizens Guide, put out every March, has been telling us for decades that Social Security, Medicare and Medicade are underfunded and will become a problem. Their charts always showed these programs becoming a disaster in the mid 2010s (now).

It's harder to blame corporate pensions for being underfunded when the US Government can't even adopt fiscal responsibility.

Of these, perhaps the saddest is the baby boomers. Their the ones who will suffer the consequences. I read a, a few years back now, that the average total savings of baby boomers was something like $15,000. Really? These are people now in their late 50s or early 60s and they have saved less than enough to buy a new car, for their entire retirement?

Amazing.

I don't want to be considered a part of the baby boomer generation any longer. Can we come up with a subset of that generation named something else, perhaps the Malthusians?