History and evolution of retirement plans in the US
The beginning of the development of retirement plans in the US can be traced back to certain key events in American history. This unfolded alongside the development of pension schemes in other countries across the world.
Pensions were initially extended to people in financial need, soldiers and war veterans.
Some records describe a monthly lifetime income benefit offered to soldiers during the American Revolution, later offered by the government in the Civil War and other wars.
From the mid 1800s, according to certain records, municipal workers in some US cities started receiving public pensions. In 1875, the American Express Company started offering the first employer-provided retirement plan in the US.
By the 1920s, several American industries such as banking and railroad companies, started offering pensions to their employees. The federal government established a plan for its employees in 1920.
The pension was offered under the Civil Service Retirement System (CSRS). The Civil Service Retirement Act became effective on August 1, 1920. The CSRS is a Defined Benefit (DB) retirement system.
The US’ Social Security program contributed to the development of private pensions. To bridge some of the gaps in the private pension system, the US Congress enacted measures such as the Employee Retirement Income Security Act (ERISA), in 1974.
According to the website of the US Department of Labor, ERISA is “a federal law that sets minimum standards for most voluntarily established retirement and health plans in private industry to provide protection for individuals in these plans”. As per ERISA, participants should be provided with information such as features of the plan, and funding.
Subsequent legislations ensured benefits for lower-paid and older workers, and other groups.
ERISA also brought in the Pension Benefit Guaranty Corporation (PBGC) to guarantee uninterrupted payment of pension benefits for private sector plans in case such plans fail.
The guaranteed pension was referred to as a Defined Benefit (DB) plan. Employees could know how much they would get when they retired, save more if required, and plan their future around it.
DB plans were used by employers in several countries to attract and retain workers. However, in countries such as the US, UK and Canada, more and more participants are moving to Defined Contribution (DC) plans.
DC plans (such as 401(k) plans, 403(b) plans, and profit-sharing plans) do not promise a specific amount of benefits when the employee retires. As the DOL website describes it, in DC plans “the employee or the employer (or both) contribute to the employee’s individual account under the plan, sometimes at a set rate, such as 5 per cent of earnings annually”. These contributions are usually invested. The employees will receive the balance in their account based on contributions, plus or minus investment gains or losses, according to information on the DOL site.
The shift from DB plans to DC plans began in the 1980s. Some of the main reasons for the shift were to help employers lower administrative costs and to achieve more predictable funding costs, and, to a certain extent, changes in worker demographics.