The Rise and Fall of the American Pension
(This is the first installment of a three part series.)
They used to roam the annals of the corporate benefits arena like the proverbial big man strutting on campus. They represented the Holy Grail of corporate America during the era of the Organizational Man (that would be the 1950s for those too young to remember). But, like so many great inventions before them, they calcified into something akin to a boulder-like albatross dangling from a noose around their sponsoring companies’ necks. Today, while a few fossils remain, they are the exception rather than the rule. They’ve become a mere footnote from a time before workers gained their independence. They now represent an era of the distant past, when paternalism reigned, shackling individuals to lock-step conformity.
What led to the fall of the American Pension? Once a sign of enlightened progress, it has grown to symbolize economic stagnation and defeat. To appreciate the reason for its demise, we must first explore the reason for its ascendance.
Although they existed from the very start of our nation, it wasn’t until the birth of rock and roll that they become universally accepted and expected. “Pensions have been around in America since Revolutionary War times,” says Matthew Reischer, Esq., CEO of New York City based LegalAdvice.com. “The pension as popularly known today, which is similar to a fixed sum annuity paid regularly upon retirement, became popular in both the public and private sector following World War II.”
The shift from an agrarian economy to a manufacturing economy prompted the need for some basic form of pension. Robb Hill, President of R Hill Enterprises, Inc. in Aurora, Illinois, says the benefit came about “because of the industrial revolution. Manufacturing needed a lot of workers. Where were they going to get these workers from? The answer: from all the farmers and the small business owners of that time. The owners of industry realized that in order to get these people to leave their farms and their small businesses, there had to be an incentive. This is where the promise of ‘30 years working here and the company will take care of you in your old age’ came about.”
The turn of the nineteenth century into the twentieth represented a very different model for both corporate America and its workers. This was the age of the company town – for good and for bad. It was a time when one “sold their soul to the company store.” Daniel J. Dingus, President and Chief Operating Officer and Director of Portfolio Management at Fragasso Financial Advisors in Pittsburgh, Pennsylvania, says, “Pensions were born from the paternalistic nature of corporate America in an era when employees may have stayed with one company for their entire career. Many companies offered housing, the company store and (as such) a pension after retirement.”
During the era that saw the birth of Social Security, using the military retirement benefit as a model, the government began funding private pensions across the board. Unions fought for corporate pensions, and these soon became the de facto benefit of private employment. Some say these corporate pensions offered a counter to the then growing global attraction to communism and socialism. Brent Leavitt, Healthcare and Financial Adviser at Nevada Benefits in Las Vegas, Nevada says, “Pensions came about as a social safety net and were built by governments who were able to tax the people and then disperse the money to certain groups. The first pensions came about to help fund widows. When a husband passed away, women couldn’t just remarry and women didn’t have the ability to really own any land or get much gainful employment.”
Pension plans blossomed during the Depression and flourished when the American economy led the world. The precise features of the pension benefit became an important differentiator between companies competing for the best talent. “The use of pensions really took off in the United States after World War II,” says Leavitt, “but they were used by the government well before to fund servicemen. Everything comes down to economics when we speak about money and benefits. The rise of pensions has always come about when the supply of workers is far less than the demand. In order to attract and retain people to stay with your company or to sacrifice their lives to the military, it becomes important for a company to come up with a way to not only increase pay to meet the demand for workers, but to find a way to keep them and reward them for it.”
While there was a competitive reason to offer a corporate pension, changing tax laws soon provided an economic value as well. “The concept of pensions was a way for businesses to ‘take care’ of their employees when they retired,” says Tom Scanlon, a financial advisor at Raymond James in Manchester, Connecticut. “They were popular with employers as they would get a tax deduction and use the pension plan as a tool to attract and retain employees. Back in the day, the company, the union and the government (with Social Security benefits) took care of you.”
Lawrence J. McQuillan, PhD, Senior Fellow & Director of the Center on Entrepreneurial Innovation at The Independent Institute in Oakland, California, is author of the forthcoming book titled California Dreamin’: Resolving the Public Pension Crisis. He cites these new tax rules as the impetus behind the dramatic growth of the American pension industry. “Since the primary advantage of pensions is the tax advantage tied to deferred compensation,” says McQuillan, “pensions did not really take off in American until World War II and after, when income tax rates increased and became more steeply progressive.”
So what happened to this much beloved corporate benefit? The most often mentioned “killer” of the American pension is the 401k plan. Scanlon says, “The idea of the defined contribution plan, specifically the 401k plan was the beginning of the end for the defined benefit pension plan. The shifting of the funding from exclusively the employer to (almost) exclusively the employee was huge.”
There were certainly other reasons for the demise of the corporate pension plan, and they were evident long before Ted Benna discovered that little loophole in the tax code. “Private pensions became ineffective over time but certainly accelerated in the late 70s and early 80s,” says Dingus. “Longevity, a slowing economy, and liabilities all put pressure on the pension model. General Motors is one of the classic textbook examples of a company saddled with pension obligations. Certainly the introduction of the 401k presented an alternative to those concerns and the need to reduce liabilities.”
Rampant inflation, at the very least, was a very willing accomplice in the death of pensions. Retirees needed an alternative that could keep pace with the cost of living. Reischer says, “The demise of private pensions truly took root with the Federal Reserve’s excessive money printing of the 70s. This made fixed income revenue streams worth less. The 401k was introduced in the 80s and was the final nail in the coffin for the pension plan. It is no coincidence that the 401k allowed Wall Street access to excess money that previously funded pensions but now could be speculated on equities, bonds, and other financial instruments.”
But would pensions have survived without high inflation and the introduction of the 401k plan? It appears various demographic trends may have doomed them anyway. “Private pensions became ineffective after World War II, when more people started living longer,” says Leavitt. “No longer did companies know how to properly fund the pensions fully. To make a pension work, it is important to fund it heavily in the early years in order to really capture the investment growth.”
Beyond demographic trends, the push to win more benefits may have also shortened the life of the pension plan. Ilene Davis, Financial Independence Services of Cocoa, Florida, believes the writing was on the wall “when vesting periods were shortened, when unions got involved, and when people started living so much longer.”
It goes beyond our country’s shores, too. With the great success due to the commitment on the part of the United States to rebuild the world economy following World War II came new competition from overseas markets. Gone were the days when benefit negotiations could take place within a closed economy. McQuillan says, “As the U.S. economy became more competitive globally given new technology and fewer trade barriers, margins shrank, and benefits have shrank too. Also, the primary advantage of pensions is the tax advantage tied to deferred compensation. These advantages have dwindled as income tax rates became less steeply progressive over time, especially at the federal level.”
With the diminishing tax advantage and the swelling competitive pressure, Hill says, “Private pension plans have become far too expensive for employers because of people living longer, the cost of health care and many other variables that have taken away from the bottom line of businesses. We must not forget that the role of business is to make money.”
Today, as the memories of the Ancien Régime of the pension plan fade into rose-colored hues, we hear voices lamenting of the “good old days,” when “everyone had a pension they could rely on.” But was this truly the case? Scanlon says, “For some it was ‘the good old days,’ for others, not so much. Depending on where you worked and when you retired, it made a big difference.”
But these are no longer the days of the company man spending his entire career at the same firm. “Pensions served many purposes early in the development of corporate benefits,” says Dingus. “Many employees reminisce about the glory days of pensions while not recognizing that they now work in an environment where the likelihood of being at the same place their entire career isn’t realistic and that brevity of employment at different places during their career is more the norm.”
Unfortunately, even if those company men (and women) did stay in one company all their lives, those lives tended to end earlier than today. For some reason, this fact appears to have slipped from the popular consciousness. Leavitt says, “Most people always see the past differently than what really happened. Since it is all in our minds, we get to paint the picture. I hear all the time that life expectancies were lower in the past, so it was much easier to make a pension promise at a lower cost. Most people were promised these pensions, but most of them would never live to that day. The statistics of how many workers actually had a pension and that actually worked long enough to get them are very different than the stories we are told. History always highlights pop culture and takes the things it wants and makes it seem like it was the norm, when in reality it was an exception.”
Part of this new reality includes changing priorities within today’s job-hopping work force. “Employees are now excited for free daycare, cafeteria meals, and dry cleaning,” says Dingus. “That paternalistic view is gone. Now companies realize their obligation is more centered on employees when they are still employed and that retirement benefits consist of helping them be ‘retirement ready,’ not necessarily guaranteeing success.”
Since the rise of the 401k, workers have been able to take control of their own retirement future. The need to depend on an increasingly undependable (or, at the very least given the globally competitive environment we live in, “unpredictable”) employer has evaporated. Thanks to the 401k, we see “the millionaire next door” in every city, town, and village across these United States. “Now it’s all about personal responsibility,” says Scanlon.
That may be true for the vast number of American workers, but there remains an elite class where the pension is still the way of retirement life. We’ll visit that cohort in the next installment, “The Golden Goose Lays an Egg: Fiduciary Issues with Public Pensions.”
Interested in learning more about important topics confronting 401k fiduciaries? Explore Mr. Carosa’s book 401(k) Fiduciary Solutions and discover how to solve those hidden traps that often pop up in 401k plans.
Mr. Carosa is available for keynote speaking engagements, especially in venues located in the Northeast, MidAtantic and Midwestern regions of the United States and in the Toronto region of Canada.