By the late 1960s, the concept of retirement had taken hold. Nearly everyone saw retirement as the culmination of the American Dream. Private pension plans now covered over one-half of private sector employees.
Legislation was passed that protected workers’ pension benefits while providing tax incentives to corporations that provided these benefits. The dream of retirement was in full force, but trouble lay ahead. In 1900, 65% of Americans over age 65 still worked. By the year 2000 this percentage had dropped to 17%. The goal of getting older workers out of the workforce had been accomplished, but now the consequences of having so many people retiring started to pile up. First, the retirees needed money to live on, and most people relied on social security as their primary income source. In the 1980s social security benefits were increased and cost of living adjustments were enacted. A short-term funding crisis occurred in 1983; the retirement age was increased slightly and payroll taxes were increased. Retirement legislation increased pension funding requirements, and companies had to put even more money aside to pay the promised benefits. The cost of retirement was going up!
Most pension plans in the 1970s were defined benefit plans. This type of retirement plan defined a benefit or payout on the back end, based on age, years of service, and salary. In the case of corporate defined benefit plans, the company was on the hook for making sure there was enough money in the plan to provide the promised benefits. Businesses didn’t like the unpredictability or the cost of this type of plan. The shift in corporate retirement plans began as companies started dropping their defined benefit plans and exchanged them for defined contributions plans. With defined contribution plans the contribution is determined or set, but the account value or benefits paid out are no longer the responsibility of the company.
The advent of 401(k) plans accelerated the shift in corporate America to defined contribution plans. The tax code section 401(k) gives this type of defined contribution plan its name as well as its tax deferred status. In a 401(k) plan, the employee is encouraged to defer his or her own money into the plan, and the employer will typically provide a “matching” contribution to help the account grow. Once again, corporate America accomplished its objectives. First, 401(k) plans are easier and less costly to administer than defined benefit pension plans. More importantly, the funding level required by a company to provide a retirement benefit was reduced dramatically, and the burden of responsibility was shifted from the company back to the employee. The final value of a 401(k) plan was now the primary responsibility of the employee, based on how much he or she saved and how successful the investments were.
The sheer number of Baby Boomers entering retirement today will put a strain on the Social Security system, but the bigger issue is longevity. Retirees now live much longer than they used to. With modern advances in medicine and society in general, life expectancies continue to increase. Consequently the ratio of workers supporting retirees continues to fall. In 1940 there were 42 workers per retiree. The ratio dropped to 16 workers per retiree in 1950, and is 3.3 to 1 in 2010. In 40 years it is projected that there will be just two workers per retiree drawing Social Security benefits.
Stay tuned for future posts, as we explore strategies and action plans to help you develop your personal New Retirement.