8 minute read. By Diane Buxton. Photo by Aaron Burden on Unsplash.
For almost everyone who is working, retirement is a goal or looming concern, whether it is the Baby Boomer who didn't save enough for retirement and have to find alternatives, or the Gen-Xer who's not sure what will happen to Social Security when they reach retirement age. When we're younger, it's such an abstract, far away idea that it's easy to think, "I have time. I'll save money later." We're often making less money and trying to make ends meet in a world that's getting increasingly expensive while wages are stagnating. It's also the time to buy a house and start a family, although more young people are opting out or delaying either due to lack of money and lack of interest. There are always more immediate needs for our money than some faraway future. It is not until we're in our 40's and 50's when retirement becomes close enough to be a tangible goal, and by then the amount needed to be saved seems daunting.
It would be simple enough if all we have to do is save -- but no, we also have to invest the money. We all have to be investors because inflation means money loses value when not invested, and compound interest doesn't work if we don't invest. And yet, what did people do before we had mutual funds and online brokers? How did we get to a place where we have to think about such abstract, long-term goals that our brains have a difficult time grasping? How did we make our world so complicated that we have to get out of debt, learn to budget, save for retirement, and learn to invest, or else face the consequences in our old age?
Why Study the History of Retirement?
How we ended up where we are financially isn't just a result of our own choices, but also the choices of our parents who modeled to us how to use money and what to feel about having or not having it. It’s also a result of the collective choices of society and philosophies regarding our responsibilities to one another. The history of retirement is deeply political, for a leisurely retirement in one's sixties was not a common experience 100 years ago, nor was it expected. By understanding how the concept of retirement came about and how the financial structures underlying retirement have changed over the years, we can not only make better choices for our own retirement, but also be more aware of how our current situation is not inevitable or fixed, but deeply intertwined with our choices as a society.
A Brief History of Retirement and Social Security
Before the Industrial Revolution, retirement was an unknown concept to the general population. People generally worked until they died, and they died fairly young compared to today. They likely worked on a farm, and they would gradually do less physically taxing work until they couldn't work anymore, at which point their families would take care of them. Having family and productive land provided one with economic security in old age. If someone didn't have either, they would go into poverty and rely on the charity of others when they stopped being able to work.
While old-age pensions have been in existence since the Roman Empire, they were mostly reserved for the military and members of the clergy. (1) In the mid-1800s certain United States municipal employees, including firefighters, police and teachers, started receiving public pensions. By the late 1800s through early 1900s, companies in various industries, from railroads to oil to banking, began offering private pensions. Even so, the idea that retirement was available to everyone didn’t come about until formal systems of financial security were enacted in the late 1800s and early 1900s. (2)
Germany was the first to adopt an old age social insurance program in 1889. Social insurance, in general, is any government-sponsored program in which workers contribute funds to provide for their own future economic security. Under pressure from socialist opponents, German Chancellor Otto von Bismarck introduced the program to promote the well-being of workers, keep the economy at maximum efficiency, and repel calls more radical alternatives. (3)
In the United States, a variety of factors led to the enactment of the Social Security Act in 1935. The Great Depression hit older workers especially hard, and poverty rates among the elderly exceeded 50%. As the Depression deepened, calls for old-age pensions resonated with the populace tired of enduring unemployment and poverty with little government action. Proposals for national pensions -- such as calls for an annual five thousand dollars income to every family, cap on private fortunes, and monthly income for those over sixty and unemployed -- quickly garnered popular support. In the midst of this climate, Franklin D. Roosevelt won the presidential election in a landslide with his promise for a New Deal. President Roosevelt's proposal was a form of social insurance, which by that time had already been enacted in thirty-four countries, beginning with Germany. Compared to some of the more radical proposals, social insurance was a more conservative program that still addressed the needs of the elderly. (4)
Social Security, pensions, and private savings have been called the "three-legged stool" of retirement for the decades following the enactment of the Social Security Act. We've come to expect retirement in our sixties as the normal end to the working life that allows travel and leisure activities even as we might be physically capable of working. Retirement was something we earned for working during our prime years. But things continued to change. Over the last forty years, company-funded defined benefit pensions, once part of the foundation for retirement, gradually disappeared and were replaced by defined-contribution plans like 401(k)s. Arising almost by accident, defined-contribution plans drastically increased individual responsibility for managing their own retirement funds.
The Decline of Pensions and Rise of 401(k)s
A defined benefit pension plan is what most people think of when they use the word “pension.” It's a plan where the retirement benefit is defined by a set formula, usually of the number of years worked and final pay, rather than by investment returns. The company or government that owns the pension plan is responsible for making the contractual payments regardless of how well their investment did or whether or not they were adequately funded. The risk of running out of money is assumed by the company or government.
Since defined benefit pensions are owned by a government entity or a private company, they required that the worker stayed at the company for a minimum number of years. This requirement forces workers to stay with a company and aren't portable to other jobs, making it more useful for larger, more stable entities that don't experience many changes, as well as people who prefer to stay at one job for long periods of time.
In 1978, a niche and obscure section the Internal Revenue Code, section 401(k) was created to allow high-earners to invest part of their salaries in the stock market and defer income taxes. Then in 1980, a tax consultant named Ted Benna reinterpreted the code to create a simple, tax-deferred retirement savings plan which included using employer matching to give employees an incentive to contribute. Thus the 401(k) plan as we know it today was born. (5)
The 401(k) plan, also called a defined contribution pension plan, quickly rose in popularity as a retirement vehicle because it provided companies significant risk reduction. In a defined contribution plan, individuals and companies make contributions into a tax-sheltered vehicle in which earnings grow tax-free until withdrawal (depending on the type of plan). No longer would they have to make benefit payments regardless of business and market fluctuations. Instead, the defined contribution plan allowed a company to only be responsible for paying a certain amount of money into the plan -- if they provided matching funds at all. The employee assumes the risks of market fluctuations and can choose not to contribute, making it far easier to not fund one's retirement if there are money challenges in the present. The risk of running out of money in one's old age is now placed on individuals instead.
The Downside to 401(k)s and Individual Responsibility For Retirement
Since the transition from defined benefit to defined contribution plans, private savings (which is what a 401(k) boils down to) have become an increasingly important part of one's retirement plan. It is even more true today, since Social Security trust fund reserves are expected to run out by 2034. Since funds collected from Social Security payroll taxes are currently not enough to pay benefits in full, benefits may be reduced or retirement age may be increased if the laws do not change. (6) Unfortunately, as individual responsibility for retirement planning increased, their financial knowledge has not. The move to defined contribution plans placed the burden of understanding investing and the stock market on individuals, whose financial education is still to this day mostly self-taught, since financial education before college is nearly non-existent. If we were lucky, our parents taught us about money management, although money is a still a sensitive subject that parents usually don't discuss with their kids. Instead, many of us learned money management by watching how our parents spend and manage money.
Through 401(k)s and other private savings, individuals are now expected to invest in the stock market to keep up with inflation, and they are exposed to the ups and downs of the stock market without being investment savvy or emotionally prepared. Instead, they're left with following the advice of investment advisers who basically give the same advice to everyone -- diversify our assets, use dollar cost averaging, and leave our money alone because the stock market goes up over time — assuming that it continues to do so.
The downside of using investment advisers is that they usually make money on the total amount of client funds under their management. It is in their best interest to keep our money invested no matter what the stock market is doing. Not to knock investment advisers or anything -- unless we have the time and interest to study investing, this is probably the safest thing to do. But this strategy does not protect individuals from the market cycles. We can only hope that we don't have to retire and withdraw money during one of the downturns.
While having more control over one’s retirement funds and being able to take them with you when you leave a company is positive development in some ways, it has been detrimental in other respects. Without adequate financial education, along with easy credit and constant advertising competing for our dollars, it has become far easier to spend than to save — which very few outside of ourselves will encourage us to do.
Understanding the history of retirement and its increasing complexity helps us realize where the work is to securing a comfortable standard of living in our old age. On an individual level, this information may help us understand how it is more important than ever to learn to budget and put money away for retirement as early as we can. While we are still the only ones who can change our situations, it’s important to understand that where we end up is a combination of environmental factors and individual choices. It is not our fault if we don't have a habit of saving that was never nurtured in us, and there is no shame making changes, now.
On a collective level, it's important to remember the role that Social Security has had in providing financial stability for not just those who are of retirement age, but also those who are disabled and dependent. Politics — which are our collective choices — do have significant impact on our daily lives and deserves our attention and participation. If we don't like the trend that Social Security and the nature of retirement is headed, it's up to us to elect representatives that reflect where we want to go.
Suggestions for action:
1. Robert L. Clark, Lee A. Craig, Jack W. Wilson (2003). "A History of Public Sector Pensions in the United States" (PDF). Wharton School of the University of Pennsylvania. Archived from the original (PDF) on February 27, 2016. Retrieved 8 December 2018.
2. Laskow, Sarah. "How Retirement Was Invented". The Atlantic. Retrieved 7 December 2018.
3. "Otto von Bismarck". Social Security Administration. Retrieved 7 December 2018.
4. "Historical Background and Development of Social Security". Social Security Administration. Retrieved 7 December 2018.
5. Elkins, Kathleen. "A Brief History of the 401(k), Which Changed How Americans Retire". CNBC. Retrieved 7 December 2018.
6. Terrell, Kenneth. "12 Top Things to Know About Social Security". AARP Bulletin. Retrieved 7 December 2018.
p.s. I highly recommend giving the article "Historical Background and Development of Social Security" a read. It's quite a fascinating process how this program that affects so many came about during the Great Depression.