There was a time when the word pension meant one thing. Putting in your years at a company meant that you could walk away knowing you’d get a steady paycheck through your retirement…but not anymore. Over the last few decades, the once-standard pension has nearly disappeared & replaced by accounts that work very differently.
So how did the pension die? And how did this change retirement? Let’s find out.
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Key takeaways
What you’ll learn here:
- Key dates for the first American pensions & why employers adopted them
- The legal changes that rewired retirement plans
- The decline of traditional pensions & growth of 401(k)-type plans
- Reasons why employers moved away from pensions
- How retirement plans work differently today
Where pensions started in America
You might be surprised to learn that the idea of a retirement promise in the U.S. began with soldiers, not office workers. It also started way further back than most people realize. In 1776, the Continental Congress passed a law that guaranteed half-pay for life to soldiers disabled during the Revolution. They later expanded this system for other veterans.
However, private companies didn’t start offering pensions until much later. In 1875, American Express rolled out what many scholars consider to be the first corporate pension.
But these early plans weren’t exactly trying to be generous. Nope, they were simply a way to keep good workers & cut turnover. They also encouraged older employees to retire on schedule.
How pensions grew through the mid-1900s
Pensions became a normal expectation by the mid-20th century, especially for those who worked for a large company or belonged to a union. These “defined benefit” (DB) plans promised a formula-based check each month. This was usually tied to your salary & years on the job.
After World War II, participation in the pension program increased massively. In 1989, nearly two-thirds of full-time workers at large firms had DB pensions. Yet that number had already slipped to half by 1997. Such a drop was an early sign of what was coming next.
The law that reshaped pensions
Unfortunately, pensions had problems. One famous case was Studebaker’s 1963 plant closure in Indiana, where thousands of workers found out their pensions weren’t fully funded. Naturally, people were outraged. The negative reception from this case & similar ones helped push Congress to pass the Employee Retirement Income Security Act (ERISA) in 1974.
But ERISA didn’t actually kill pensions. In fact, it was meant to protect them. The law required plans to meet funding standards & report to the government. They also had to follow strict rules. It also created the Pension Benefit Guaranty Corporation (PBGC), an organization that steps in when a company can’t pay the benefits it promised.
But all these regulations made pensions more complicated & costly for employers.
The 401(k) arrives and spreads
Shortly after ERISA, a change in the tax code gave people a new way to make money during retirement. In 1978, Congress added Section 401(k). This allowed employees to set aside part of their salary before taxes, with the IRS clarifying how it worked in 1981. Companies quickly jumped on it.
It began as a side option. Soon enough, though, it became the main way Americans saved for retirement.
In 1975, private DB plans had about 27 million active participants & DC plans, like 401(k)s, had around 11 million. But in 2022, DB plans had about 11 million participants & DC plans had more than 92 million.
By 2023, only about 3% of private workers had access to just a DB pension. A little over half only had a DC plan. Worst of all, around 40% of workers who still belong to a DB plan are in “frozen” plans that don’t let them earn any new benefits.
Why employers moved away from DB pensions
So why did employers change their plans? According to researchers, there are two main reasons:
- DB plans tied companies to promises decades into the future
- DC plans were cheaper to run & had less paperwork
The cost of funding DB plans rose & fell with markets and interest rates, making them rather volatile. They were also harder to manage & accounting rules made it more obvious on the company’s books.
Plus, newer industries and younger firms were more likely to go with DC options from the start. After all, they were a lot less work.
The drop in unions was also important. Union contracts had been a major force behind pension coverage in manufacturing & other industries, but as union membership declined, so did DB plans.
How plan mechanics & retirement changed
Retirement savings look completely different today.
In a DB plan, the company carried the investment risk & promised a set monthly check. In a DC plan, the worker puts money in an account. They invest it…and just hope it grows. Pensions usually provide employees with their lifetime income. However, DC plans rely on lump sums or withdrawals from savings, though some include annuity options.
Auto-enrollment is also more common in 401(k)s, bringing workers in automatically. That’s quite different from the old opt-in style.
In terms of dollars, the money companies spend on retirement plans has moved towards DC. In 2022, about 70% of employer retirement costs went to DC contributions.
Pensions promised a formula-based, steady income for life. 401(k)s put savings in individual accounts where balances rise & fall with the market. The PBGC also insures pensions, but not 401(k)s.
Today, most retirees depend on their own contributions & employer matches along with Social Security. There was once a time when retirement meant a promise. Now it’s just a personal account.
Sources: Please see here for a complete listing of all sources that were consulted in the preparation of this article.
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