This year marks half a century since the sweeping Employee Retirement Income Security Act introduced the “three-legged stool” of retirement saving that we use today. This milestone provides an excellent opportunity to review how we have used retirement accounts over time and how those strategies have evolved.
By studying the history of retirement accounts, you can better understand the options available today. Then, you can tailor your retirement plan to harness the benefits of various tax-advantaged accounts and create the retirement you envision.
1875: The First U.S. Pension Was Established
In the early history of the U.S., veterans were covered by pension programs, but private industry workers had to rely on their own means for retirement. That changed in 1875 when American Express created the first private pension plan. The initial plan applied only to disabled workers, but utilities, banks, and manufacturing companies soon began offering expanded pension options.
Congress introduced corporate income tax deductions for pension plans through the Revenue Acts of 1921 and 1926, which encouraged more companies to establish pensions. Eligibility and benefits of these early programs varied by sponsor, but most provided a stated monthly retirement benefit based on salary and years of service.1 The guaranteed income from these plans was integral in creating income security for retirees.
While early pension programs provided significant benefits for covered workers, the programs also had downsides. First, pensions were discretionary – meaning employers could modify or suspend them at any time. Second, only a few industries implemented them – leaving the vast majority of Americans without a formal retirement plan. Both issues would eventually be solved with legislation, though it would take devastating economic upheaval to spur Congress into action.
1935: Congress Created the Social Security Retirement Program
At the height of the Great Depression, only 15% of the workforce was covered by a formal retirement plan. Due to this lack of guaranteed retirement income, over half of elderly Americans lacked the means to support themselves and homelessness was rampant. In response, many states introduced pension programs to help workers fund their retirement, but these programs were often too restrictive to be widely effective. A national program was needed, and Congress provided it through the Social Security Act of the New Deal.
The Social Security program began in late 1935 and functioned in much the same way it operates today. Workers paid into the system throughout their lives and then received a guaranteed monthly benefit in retirement. In essence, Social Security built on the successful introduction of pension plans and expanded the concept to the entire nation.
Since monthly benefit payments began in 1942, Social Security has been a reliable part of the retirement plan for most Americans. It provides guaranteed income in retirement that is backed by the U.S. government – avoiding the risk associated with early private pensions.
As retirees well know, Social Security is often insufficient to cover all retirement expenses. For that reason, most retirees still need a company pension or sufficient personal savings to support themselves. The next major piece of retirement legislation aided in both of these supplementary retirement savings needs.
1974: ERISA Added Pension Protection, Created the First IRA
More employers began sponsoring retirement plans throughout the decades following the Great Depression and 45% of all private sector workers were covered by a pension plan by 1970.2 However, pensions were not nearly as secure as they are today.
The wakeup call came when the Studebaker auto plant closed in 1963. After the collapse, 4,000 employees received only 15% of the retirement benefits they were owed, and another 2,900 employees received nothing at all. It took nearly a decade for Congress to respond to the situation at Studebaker, but the legislation they created was a massive overhaul to the retirement system.
The Employee Income Security Act of 1974 – commonly shortened to ERISA – shored up the pension system and added protections for participants. Pension sponsors had to meet the strict new requirements to continue receiving the tax advantages of their retirement plan, so the changes were quickly adopted.
ERISA also created a new way for Americans to save for retirement – the Individual Retirement Account [IRA]. This type of account is still very popular today because it grants the account holder complete control of their account including contributions, distributions, and investments.
IRAs were the first step of a drastic shift away from “defined benefit” plans and toward “defined contribution” plans. The newer defined contribution plans base your retirement income on your saving and investing decisions, rather than your length of service at a particular company.
1978: Congress Introduced the 401(k) For Retirement Savings
Just four years after the IRA was created, Congress enabled another type of “defined contribution” plan – the 401(k). These plans are named after the section of the Revenue Act of 1978 that created them.
Since the 1980s, 401(k)s have grown in popularity while traditional pensions have become less popular. In fact, the number of participants in pension plans fell from nearly 50 million in 1980 to about 11.6 million in 2022 while participants in defined contribution plans grew from just under 19 million to nearly 88 million over the same period.3
For employers, 401(k)s are advantageous because they typically have a much lower cost and administrative burden than pensions. In turn, employees bear greater responsibilities to manage their own retirement funds but also gain the ability to choose their own investments – which is not the case with pensions. In short, 401(k)s shift the burden of retirement saving from employers to employees.
1997: The Roth IRA Was Introduced
Both investors and the IRS gained an attractive new retirement savings vehicle in 1997 – the Roth IRA. This type of account was named after Delaware Senator William Roth, the legislative sponsor of the plan.
The Roth IRA is unique because it is “non-deductible” – meaning that contributions cannot be deducted from taxable income. Instead, the tax benefits come during retirement when investors can make qualified withdrawals that are tax-free.
The IRS benefitted from this type of plan because they gained tax income immediately, rather than once investors retired. Patient investors can also benefit from this type of plan because the earnings inside their account are never taxed, as long as they meet the criteria for a qualified withdrawal. Additionally, Roth IRAs are not subject to Required Minimum Distributions [RMDs], making them even more advantageous for wealthy investors who don’t need to spend their retirement savings.
2001: 401(k) Plans Gained a Roth Option
The Roth IRA proved popular after its introduction and just four years later Congress added a Roth option to 401(k) plans as well. The new option – introduced through the Economic Growth and Tax Relief Reconciliation Act of 2001 – allowed more people to take advantage of tax-free withdrawals in retirement.
There were two main drawbacks of Roth 401(k) plans compared to Roth IRAs. First, Roth 401(k)s were still subject to RMDs. Second, Roth was only available for elective deferrals – the funds that an employee adds to the account. Conversely, contributions from employers – such as matching – were still required to be designated as “pre-tax.” Fortunately, both issues were resolved with recent legislation.
2022: Roth 401(k) Was Expanded to Employer Contributions
The SECURE Act 2.0 introduced sweeping changes for retirement plans, including eliminating RMDs for Roth 401(k) accounts. Additionally, the 2022 legislation added the option for employer 401(k) contributions to be designated as Roth.
With the latest changes, you have more options than ever to save for retirement – and save on taxes while you do it! All that is left to do is choose the right type of plan for your situation – and start saving.
Meld Financial Can Help You Choose the Right Retirement Account
When you partner with Meld Financial, our experienced team will help you choose the right type of retirement account for your unique situation. We do this through our comprehensive wealth management program, Financial Fingerprint® – which accounts for the most important aspects of your retirement plan from investments to tax minimization.
Our team of tax, legal, and investment professionals has spent forty years helping clients navigate the intricacies of retirement planning and we can help you as well. To learn more about Financial Fingerprint® and start turning your retirement goals into a reality, contact us today.
Sources:
1Seburn, P. (December 1991). Evolution of Employer-Provided Defined Benefit Pensions. Monthly Labor Review: Bureau of Labor Statistics.
2A Timeline of the Evolution of Retirement in the United States. Georgetown University Law Center. (2010).
3Private Pension Plan Bulletin Historical Tables and Graphs 1975-2021. Employee Benefits Security Administration United States Department of Labor. (2023).
