The Rise and Fall of Employer-Sponsored Pension Plans
During the Roaring '20s, the United States went through a massive economic boom led by technology as a vehicle to bring conveniences to everyday life—from the emergence of radios that brought entertainment and news to peoples' living rooms to the mass production of automobiles that allowed them to travel more efficiently or take a leisurely Sunday drive. Urbanization took hold and skyscrapers were built to show off the country's strength and prosperity. And although Prohibition was in full effect, that didn't stop many from drinking in the good times.
Some private companies and the public sector offered pension plans to help employees keep paying the bills after retirement, but who could be jazzed about retirement planning with The Charleston playing on the phonograph? With a prevailing carpe diem attitude and a soaring stock market, it must have felt like the soiree would never end.
But parties can't last forever.
For the U.S. and much of the world, the stock market crash in October 1929 ended the good times and brought about a Great Depression that would plague the country throughout the 1930s and lead to an unemployment rate of 37 percent. But for those people lucky enough to be employed in the 1930s, private pension plans, while still rare, survived. From 1929 to 1932, only 3 percent of workers with company pensions saw their plans discontinued, and, somewhat surprisingly, the number of company pension plans increased by 15 percent.
One exception, according to the Congressional Budget Office, was the railroad industry. When employers failed to pay promised benefits, the federal government established the railroad retirement system in 1935 to enable the depleted pension funds to meet their obligations.
During this period, most elderly people had little means of support. Millions of Americans who saw their life savings swept away during the Depression were becoming more aware of a need to provide for their future economic security.
To calm those fears, President Franklin Delano Roosevelt signed the Social Security Act in 1935, providing basic income protection to retired workers. As the economy improved, the creation of pension plans increased. But Congress became worried that pensions were being used as tax-avoidance schemes for the wealthy and passed the Revenue Act of 1938 to address that concern.
It's no wonder that U.S. workers became increasingly interested in defined benefit retirement plans. "It's hard for us to imagine the 1930s today, because what happened then would never happen now, because we have institutional safety nets," says Randall Holcombe, DeVoe Moore professor of economics at Florida State University in Tallahassee. "If you lost your job, you had to rely on your family, and there was no guarantee of their financial security."
Thanks to New Deal policies and companies' initiatives in the '30s to ensure that workers' pensions were safe, at least two generations grew up under the assumption that if they had a job with an established company, a retirement plan would help pay future bills. Many of today's workers' parents and grandparents left the workforce with some type of employer-provided income—from the time they retired until their death.
Employer-sponsored pension plans, combined with Social Security benefits and, more recently, defined contribution plans, have truly turned retirement into the "golden years" for millions of workers. So until the past decade, workers didn't put much thought into saving for retirement, much less worrying about it.
Today, "Defined benefit plans are dead," says Bob Pearson, CEO of Pearson Partners International in Dallas. "No company I know offers them even as a means to attract senior executives."
Pearson, who works with small employers on their retirement plan offerings, says that today's mainstream retirement device, the 401(k) plan, is not the answer, especially for senior executives.
"For now, we can use stock options, grants, equity and cash, but once the war for talent heats up again ... and it will ... we will see improvements in long-term benefits from the current anemic state.
While pension plans are going the way of Kodachrome film, which was introduced in 1935, at least many of today's workers have some sort of retirement plan—albeit many of which are defined contribution plans, i.e., 401(k)s, where the investment burden falls squarely on the employees' shoulders and not the company's. But at least today's workers have that. Prior to the 1920s, few industrial workers had any kind of safety net for their retirement years.
Auto manufacturing giant Ford Motor Co., for example, didn't start offering hourly employees a pension plan until 1950.
Eastman Kodak Co., on the other hand, was an exception. Under the direction of George Eastman, the company established various employee benefits, including a formal pension and accident fund dating back to 1911. In a January/February 1936 issue of Personnel Journal, Workforce Management's forebear, C.P. Cochrane in the industrial relations department of Kodak argued: "In the first place it is a mistaken industrial relations and public relations policy, especially under present conditions to dispense with the services of older employees without some reasonably adequate financial provision." Times have changed. Kodak, which recently filed for bankruptcy protection, is now struggling to survive. But worker pensions for its 63,000 employees appear safe. According to the Pension Benefit Guaranty Corp., a federal agency that protects pension benefits in private-sector defined benefit plans, Kodak's pension plans are "reasonably well-funded" at 86 percent with $4.9 billion in assets to cover $5.6 billion in benefits.
From 1940 to 1960, the number of people covered by private pensions increased from 3.7 million to 19 million, or to nearly 30 percent of the labor force, according to the Employee Benefit Research Institute, or EBRI, and by 1975, 103,346 plans covered 40 million people.
The key event in the push for pension reform occurred in 1963 when South Bend, Indiana-based car manufacturer Studebaker Corp. saw its pension plan collapse as a result of the company's bankruptcy. That event resulted in a 10-year push for federal legislation to oversee pensions, culminating in passage of the Employee Retirement Income Security Act of 1974, known as ERISA. Amended several times since, ERISA requires companies to adequately fund their pension plans and mandates that workers vest their pension benefits after a minimum number of years.
ERISA also established the Pension Benefit Guaranty Corp. In 2009, the agency guaranteed payment of basic pension benefits earned by 33.6 million workers and retirees participating in about 27,650 single-employer pension plans, according to the EBRI. And in 2010, the agency was paying benefits to 1.3 million workers from 4,140 terminated plans.
"ERISA had an effect on traditional pension plans and killed some of them, but overall it was good legislation," says James van Iwaarden, consulting actuary with Minneapolis-based Van Iwaarden Associates. "When defined contribution plans were first introduced in the late '70s, they were never intended to replace defined benefit plans, but to supplement them," he says.
Van Iwaarden says that legislation passed since the 1980s, most recently the Pension Protection Act of 2006, has changed funding rules for defined benefit plans, forcing plan sponsors to focus on the short term as opposed to the long term—which is one reason those plans are considered more risky than in the past.
"These changes have caused significant problems for employers both with financial statements and funding responsibilities that would not have occurred with the old rules and the old ways of investing," van Iwaarden says. "I believe this has caused employers to move away from defined benefit plans and the volatility involved with funding them and to shift both the cost and risk for retirement benefits to employees."
Pension plans have been declining since 1984: In 1983 there were 175,143 plans, but in 2008 there were only 46,926 plans.
Van Iwaarden says factors contributing to pension plan decline and decreased funding include market volatility, declining interest rates and the burst of the technology bubble in 2000.
In a 2011 survey of 546 employers across a variety of plan types, sizes and industries, consulting firm Aon Hewitt reported that 57 percent of employers surveyed offered both a traditional pension plan and a defined contribution plan (down from 64 percent in 2009). Of those with traditional pension plans, only 44 percent remain open to new hires.
And according to benefit consultant Towers Watson & Co.'s analysis of Securities and Exchange Commission filings, 237 of the 584 employers on 2011's Fortune 1000 list that sponsor defined benefits plans have frozen at least one plan.
Frederick Reish, a partner based in the Los Angeles office of Drinker Biddle & Reath, says that, in the foreseeable future, the emphasis will be on participant-directed, deferral-based defined contribution plans.
"However, because of the inherent weaknesses of those plans, we'll see changes. For example, sponsors will no longer assume that employees know how to properly invest their money."
Reish says that automatic enrollment may become the norm, though "Congress is disagreeing on that right now." And increasing participation will be a priority, with the expectation that 80 to 90 percent of employees join the plan.
"More sophisticated products are coming, including Guaranteed Minimum Withdrawal Benefits, which protects investors against downside market risk," Reish says. "Ultimately, I believe that most people don't know where they are going, how much they need to get there or how to get there when it comes to retirement. I think the retirement age will have to change as well as the American way of thinking. Seventy is going to be the new 65."
Chad Parks, CEO and founder of the Online 401(k), a flat-fee 401(k) provider based in San Francisco, says that auto enrolling employees in defined contribution plans, and implementing auto increases and even default investments might help prepare them for retirement, and future legislation may require all businesses to offer an Individual Retirement Account option for workers.
"Companies like Intuit are building in savings as part of their tax software, where the user might see a pop up that says, 'You have extra money, why not consider investing in an IRA?' " Parks says. "We have a looming retirement crisis, and we need to make saving easy and automatic. The government isn't helping, and I don't see any new product, regulation or tax change that will help. I think it's more of a generational thing where you are going to see younger people save more on their own. They will find a way, and new technology will help."
Nicholas Olesen, a private wealth manager with the Philadelphia Group, believes that traditional pension plans will continue to decrease, with companies modifying them going forward or freezing them completely and turning to defined contribution plans.
"I'd be shocked to see defined benefit plans after 2020, though there may be some in unions and professional firms," Olesen says. "Funding requirements are a big obstacle, benefit formulas are unrealistic with the market we've had recently, and the legal costs to terminate a plan is astronomical, so you're going to see employers freeze their current plan and implement creative savings opportunities for new hires."
Other experts agree that new products may include low-volatility funds that reduce market risk, cash-balance plans that define the promised benefit and guaranteed income plans.
"Most people are ill-suited to manage their money, so what we might see going forward is one of these hybrid plans, in a defined contribution environment, where the employee still holds the risk but has a more stable retirement fund," van Iwaarden says. "And I would still not be surprised to see some resurgence of defined benefit plans for tax-motivated employers."
Lisa Beyer is a Workforce Management contributing editor. To comment, email email@example.com.