By: Pamela Martinez, JBS Corp
How it all Started
From a young age, retirement is sold as the ultimate goal in the American dream. We are told to go to school, work hard, and, most importantly, save so that we’ll have enough money to retire and embark on the leisure activities we’ve been longing for. Be that as it may, have you wondered why we should retire at a particular age or why we must begin saving at such a young age?
It may seem as though retirement is a tale as old as time, but much to our surprise, it’s a relatively new practice created in the late 1880s in Germany. The concept of retirement was created as an incentive to lure older stakeholders (65+ years old) out of the workforce to open job opportunities for younger citizens. The idea was incentivizing the older folks to stop working by granting them a monthly allowance for the remainder of their life, to do with as they please. This made sense for governments because the average age of mortality for the citizens was approximately 67 and a half years old. Win-win situation, right?
Wrong. This plan failed to take the evolution of medicine into account. We started to live longer this strategic asset that the government created quickly turned into a financial liability.
During the Great Depression of the 1930s, unemployment shot to as high as 24.9%. To stabilize the economy, President Franklin D. Roosevelt (FDR) implemented the New Deal, a series of public work projects and financial reforms. Thus, came the Social Security Act of 1935, introducing the first form of a public retirement plan in the United States. The concept was similar to that of the Germans, incentivize your older citizens to retire by providing a guaranteed monthly income, simultaneously opening up jobs for the younger American population. Prior to innovative policies like Social Security and private pensions, the concept of leaving work at a certain age, generally, mid-60s, to pursue other pass times was ludicrous.
The Private Pension
In the mid-1800s, municipalities around the United States began to implement public pensions to employees, including firefighters, police officers, and teachers. In 1875, the American Express Company began to offer private pensions to its employees. By the 1920s, a variety of American industries began offering pensions. In theory, pensions are excellent sources of funding during retirement. Pension funds were easily comprehended, provided stability, and, more importantly, the company handled the retiree’s investment risk. Of course, we would soon discover that these plans were “unsustainable” and did no favors to the companies who had promised them to millions of Americans.
Before the 401(k) plan gained popularity and became the most common way of saving for retirement, working Americans relied on the pension plan to get them through retirement. A pension plan is a retirement plan where the employer assumes the responsibility of setting aside funds for their employee’s future benefits, virtually guaranteeing their employee’s income in retirement. Here’s how it works: pension plans are defined-benefits plans where employers, using actuarial science, calculated an employee’s salary, age, longevity, years of service to the company, and compensation to determine the fixed monthly amount an employee is entitled during her/his retirement.
Many of us may now be wondering, what happened to these great retirement plans? Why do our fathers, mothers, and grandparents have it, but we do not? A great Forbes article by brand contributor Impact Partners says it best, “In reality, large corporations were lobbying Congress to shut down their pension plans because they were too expensive to administer, and the employer held all of the investment risks. Corporate America needed a way to reduce costs and transfer the risk from the company onto the employee.”
In the early 1970s, approximately 46% of private-sector workers were covered by a pension plan. Now, that number is as low as 13%. Pension plans are a rare commodity to come by, and nearly every employer offers its employees the option to invest in a 401(k) plan. And the funny part is, it was all an accident. When Congress passed the Revenue Act of 1978, and it changed the tax code. Paragraph k of section 401—hence the name 401(k)—of the new tax code permitted bonuses and stock options to qualify for tax deferral. This was intended as a means to pay bonuses and stock options to employees while deferring income tax. Big fortune 500 companies saw this as a prime opportunity to save money and end the pension plan.
At the hands of retirement consultant Ted Benna, the 401(k) plan had taken effect when, in 1981, the IRS enabled companies to fund 401(k) plans through employee salary deductions. Instead of having to fund an employee’s retirement, a company can now offer their employees the option to invest in a 401(k) plan, which takes a percentage of their salary and puts it in a retirement account as means for retirement.
The Shift in Responsibilities & the Lack of Education
So, what just happened? Corporate America (primarily fortune 500 companies) went from providing us vehicles of guaranteed lifetime income in the form of a monthly pension that generally covered our cost of living for retirement until they convinced the government to change to a 401(k) plan instead. This transition saved the company money but left us (the employees) struggling to save for retirement.
Let’s not leave out how this happened without the working class being adequately informed on how impactful this change would be. How could this be? Simple, enrolling in a pension plan was thoughtless, employees were automictically enrolled when they started at a new company. That changed with the switch to 401(k) plans. With 401(k) plans, employees are merely given the option to contribute to their retirement, without being educated on what a 401(k) plan is, how it works, and with the expectation that they are well-versed in investment knowledge.
The transition left many Americans, especially Baby Boomers—who were just joining the working-class during this time—unprepared for retirement. Now, retiring in large numbers, the introduction of the 401(k)-plan, coupled with the financial crisis of 2008, have crippled Baby Boomers from effectively saving for retirement. Due to this level of unpreparedness, mostly at the hands of corporate America, the majority of Baby Boomers are predicted to fail during retirement.
Baby Boomers aren’t the only generation unprepared for retirement Gen X, Gen Y, Gen Z; we are all unprepared. Besides the lack of knowledge in investing in a 401(k), most of us start saving for retirement too late; and this could be the product of bad conversations. Imagine this: instead of approaching a young adult, age 18-24—who are unphased by the word retirement because to them it’s a lifetime away—and telling them “Hey, you should start saving for retirement!” try saying “Wouldn’t it be wonderful to achieve the point in your professional life where you no longer have to trade time for money? Where you achieve financial freedom and do not have to rely on a corporation for a paycheck?”. Why? Because financial freedom and retirement are one-in-the-same. Retirement, we know it won’t happen until at least the age of 65, but financial freedom can arrive at any time and age you choose, so long as you are willing to work hard.
A lot has changed since western civilizations’ introduction to retirement, medicine is constantly evolving, life expectancies are rising, and people are finding creative ways to earn money. So, isn’t it time we redefine what it means to retire?
