This is the final part of our series My Financial Coach Presents: History of Retirement. Click Here to start at the beginning and view our video and timeline as well.
Trouble in Pension Paradise
By the 1950s, almost 10 million American employees, or around 25% of the private workforce had a pension. In just ten years that number would increase to nearly 50% of the private workforce.
Historically, the IRS was primarily responsible for regulating private pension plans. However, in 1959 with the passage of the Welfare and Pension Plans Disclosure Act (WPPDA), the U.S. Department of Labor became involved. This act would require plan sponsors to keep better records including filing plan descriptions and annual financial reports. In theory, this should have made pension funds more accountable. It would seem that with strengthened legislation, pensions were the gold standard with no end in sight.
Around this same time, in 1958, Dr. Ethel Percy Andrus founded the American Association of Retired Persons (AARP) an evolution of her previous efforts with the National Retired Teachers Association (NRTA). The AARP was founded to address concerns of aging Americans and acts as a lobbying group on behalf of them at both the Federal and local state levels.
Just as retirement was becoming the “buzz word” of employers, lobbyists, and the government, it also was becoming a tool for powerful labor unions. One such labor union, the International Brotherhood of Teams (IBT), or more commonly known as the “Teamsters”, had been around since 1903. By the start of World War II, they had become one of the most powerful unions in the country, and as a result, have one of the largest multiemployer pension funds in the country.
For anyone who has seen the recent Martin Scorsese film The Irishman, they might recall that Jimmy Hoffa (as portrayed by Al Pacino) was sent to prison for among other convictions defrauding the Teamsters Central States Pension Fund. Convicted in 1964, Hoffa would enter Federal prison in 1967 to begin serving several sentences including 8-years for jury-tampering but would find his sentence commuted after just 5-years later in 1972 at the behest of President Richard Nixon.
While the Hoffa conviction made headlines, just a year prior in 1963, it would be another event that would start shaking the foundations of trust in pensions. During the 1950s through the early 1960s, the American auto manufacturer Studebaker, increased its pension benefits four times in order to compete for talent amongst the Big Three: General Motors, Ford, and Chrysler (now Fiat Chrysler Automobiles US). Unfortunately, those increases were empty promises and by the end of 1963, the company had ceased its U.S. operations and terminated its pension with many participants losing the majority of their retirement.
Due to several instances of pension fraud and funding issues in the decades to come, vast changes were headed for the pension system. In-fact in 1972, NBC News produced the Peabody award-winning documentary “Pensions: The Broken Promise” which investigated alleged abuses within the pension system.
While there was some opposition to the airing of this documentary, in particular, the group Accuracy in Media (AIM) even filed a complaint with the Federal Communications Commission (FCC). NBC took the case to court, and public outrage about the mishandling of private pensions ensued. The pension was no longer the golden ticket to retirement and the 1970s were about to bring sweeping new changes to retirement.
The Rise of Private Retirement
While the Welfare and Pension Plans Disclosure Act (WPPDA) of 1959 was created to create more oversight on pension plans, unfortunately, it did not address plan failures. While there were amendments made in the intervening years, it would not be until the Employee Retirement Income Security Act (ERISA) of 1974 that more sweeping changes would occur.
Some of the biggest changes of the ERISA Act were around more stringent rules around disclosures, funding, and fiduciary duty. This act would provide participants the right to sue their provider for breach of its fiduciary duty. In addition, there was major protection against loss of retirement contributions through the Pension Benefit Guaranty Corporation (PBGC).
In addition to new pension rules, there was also the introduction of the Traditional IRA (originally called “Regular” IRAs) in the act, which allowed contributions of the lesser of $1,500 or 15% of wages starting in 1974. This account allows an individual to save for retirement along with reducing their taxable income by the amount of their contribution.
The employer-sponsored cousin of the IRA, the 401(k), would enter the scene just four years later as part of the Revenue Act of 1978. This account was designed to allow employees to defer compensation or even stock options in a tax- free account that would later be taxed upon distribution. Interestingly enough, we might just have executives from Kodak and Xerox to thank, as they had been lobbying Congress for a tax-shelter to hold their profit-sharing bonuses. Though initially designed for executives and management, it would soon help the rank-and-file to save for retirement.
While part of the revenue act the law would not go into effect until 1980. A year later in 1981, the IRS clarified rules which would allow employees to contribute to their 401(k) plans through salary deductions. This one small change would forever change how American employees would save for retirement.
More Acts Than a Shakespeare Play…
During the rest of the 1980s through the 2010s, Americans would see a number of retirement reforms, some affecting pensions and employer plans, while others affecting Social Security. While we will not run through every single act passed over the last 40 years, it is important to be familiar with the major acts that have helped shape how retirement looks today.
The Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA) would introduce “top-heavy” rules to plans which would adjust standards of vesting, contributions and benefits, Social Security integration, in those plans where 60% of the benefits accrued to only the officers or highly compensated employees). This act also adjusted Required Minimum Distribution (RMD) rules (see our previous article for a deeper dive) requiring employees to begin distributions at age 70 ½.
Shortly after TEFRA, another major turning point for retirement occurred with 1983 Amendments to the Social Security Act. Among these amendments was a new graduated system that would push the normal retirement age over time from 65 to 67. In another first, these changes also led to Social Security income being taxed. Starting in 1984, for certain taxpayers who had income above certain thresholds, one-half of Social Security income could become taxable income.
A few years later, President Reagan signed into law the Tax Reform Act of 1986 (TRA 86), which has been cited as the “Broadest revision of the Federal income tax in history”. While much of the act is synonymous with lower tax rates and new tax breaks, it also made several changes to retirement plans.
Among these changes, were adjustments to discrimination testing and vesting rules, one of the biggest overhauls being that it established a uniform rule for taxing/penalizing early distributions from qualified retirement plans. This established a 10% penalty for anyone distributing out of a plan prior to age 59 ½. Prior to this act, these early withdrawal rules were only established for IRAs.
Then, in 1996, the Small Business Job Protection Act (SBJPA) was passed. It is known for introducing SIMPLE IRA plans, as well as for making it easier for small businesses to offer 401(k) accounts. This allowed them to offer retirement plans to help small business owners attract employees. This act also redesigned some of the rules around “safe harbor” methods, as well as simplified who counts as a “highly compensated employee”.
The 1997 Taxpayer Relief Act brought with it one of the largest tax cuts in U.S. history, along with yet another IRA-type with the introduction of the Roth IRA. Sponsored by Senator William Roth of Delaware, the Roth version of the IRA allowed the contributor to put after-tax dollars into an account that could then grow and be withdrawn at retirement tax-free.
In the 1990s, America was defined by a period of strong economic growth, and companies found it important to retain talent by offering better access to retirement plans. By the end of the ‘90s over 40 million Americans in the private sector were covered by defined benefit plans. Another 60 plus million Americans in the private sector were covered by defined contribution plans.
While the ‘90s were marked by economic prosperity, the next decade would face greater turbulence. The dot-com bubble coupled with the September 11th, 2001 attacks marked a difficult start to the 2000s. As a measure of relief, the Economic Growth and Tax Relief Reconciliation Act (EGTRRA) of 2001 was passed with significant changes to tax rates as well as changes to retirement plans.
Major changes under EGTRRA were lower vesting requirements for employer plans, “catch-up” contributions for individuals over age 50 and older to their employer plans (which allowed additional money to put away towards retirement), and increased flexibility with rolling over employer plans to an IRA.
As the economy recovered, by 2006, the Pension Protection Act (PPA) was signed into law. This act would make several provisions from the 2001 EGTRRA permanent as well as work to strengthen the overall pension system. It was one of the largest overhauls of pension plans since ERISA, and its intention was to help close loopholes that companies were using to skip payments or cut funding into the Pension Benefit Guaranty Corporation.
While the mid-2000s seemed to be a return to the status quo of a strong economy. The end of 2007 brought about one of the most financially devastating events, the Great Recession or Financial Crisis. By 2008 the stock market was facing a downturn unseen since the Great Depression.
As a result of plummeting investment portfolio values, in late 2008, the President signed the Worker, Retiree, and Employer Recovery Act of 2008 (WRERA) into law. A major provision as part of this act is suspending of RMDs in 2009. Also starting in 2010, a major overhaul to the Roth Conversion rule would remove the restriction of having an Adjusted Gross Income of more than $100,000. The 2010 provision still stands today, and now anyone regardless of income can utilize Roth Conversion.
Despite the turmoil of the 2000s, there were some bright spots to be found in the retirement community in the 2010s. In 2016, a Department of Labor survey found that 62% of workers had access to some type of defined contribution plan, most of those plans being a 401(k). Of those with access, it was estimated that 72% were participating. By 2017, total 401(k) assets were estimated to be around $5.28 trillion.
In 2016, The Department of Labor (DOL), also proposed a new fiduciary rule holding financial advisors to a higher standard of duty to their clients. However, the U.S. Fifth Circuit Court of Appeals overturned this in 2018. This law did have the effect of creating a greater discussion about transparency and fiduciary responsibility to clients in the field of financial planning. It has also been stated that the DOL is possibly working with the Securities and Exchange Commission (SEC) to reintroduce this proposal.
Today, 401(k)s and similar employee-sponsored plans are more popular than ever. As of 2016 defined contribution plans had more than 80 million active participants. And according to the Federal Reserve data, these plans had over $5.7 trillion in assets as of the first quarter of 2018.
While pensions dominated much of the 20th Century, in just a few decades the retirement industry has quickly transformed with Congressman and entrepreneur alike likely dreaming up the next big thing in retirement. One thing is for certain, change is imminent, but the fundamentals of wanting to settle into a well-deserved retirement is a timeless concept.
As of the writing of this article, on December 20, 2019, President Trump officially signed the Setting Every Community Up for Retirement Enhancement (SECURE) Act. This act is making some major changes to retirement, the likes of which have not been seen since the late 1970s and 1980s.
A major part of this bill is to encourage more 401(k)/employer plan adoption by small businesses by making it easier (and with a tax credit) to set up plans for employees. It also encourages employers to include more part-time employees. Lastly, for employers, this act has removed many barriers to introducing annuities as part of 401(k) offerings by removing the legal responsibility of the employer if an insurance company were to fail.
For the public, some of the most noticeable, and likely welcomes changes are that the RMD age has been increased from age 70 ½ to age 72, the age cap of 70 ½ to make Traditional IRA contributions has been removed, and a new provision allows penalty-free distributions from 401(k)s (up to $5,000) towards the costs of having or adopting a child.
While many of these changes may be seen favorably, to help fund some of these changes, a major overhaul has been made to inheriting retirement assets. In the past non-spousal beneficiaries were allowed to “stretch-out” the distributions of the retirement accounts by establishing an RMD based on their own life expectancy.
The new rules only permit spouses to either assume or inherit the assets with a “stretch” provision, while non-spousal heirs must distribute the entirety of the retirement account within 10 years of the death of the original account holder. This rule will grandfather in anyone who inherited assets from someone passing before 2020 under the previous system.
Retirement – The Next Generation
The future of retirement is anyone’s guess, but if the past has shown us anything, retirement is a dynamic and changing idea. Whereas our many-times-removed ancestors may never have known a day of rest or leisure, our great grandparents might have known a military pension, our grandparents a Teamsters pension, and our parents a deferred compensation plan or 401(k). Today, we may find ourselves utilizing any number of retirement plans past and present. We leave it to future generations now only dreaming of the next “great’ retirement idea.
The concept of retirement spans generations, and as with anything worth knowing, it helps to know its history. I hope that this has been an informative and enjoyable walk through the millennia spanning the idea of retirement, and may the next generation of retirees look forward to writing their own History of Retirement.
Andrew J. Crosby, CFP®, ChFC®, RICP®
Lead Financial Coach