The History of the Pension Plan
In financial advisor and radio personality Ric Edelman's book, The Truth About Retirement Plans and IRAs, he describes a monthly lifetime income benefit that was offered to soldiers during the American Revolution. If a soldier survived the war, the Continental Congress would reward them with income for life. It was called a pension, and it was offered again by the federal government in the Civil War and every U.S. war since.
The structure, however, was not new. Soldiers who served in Ancient Rome were also guaranteed income after they retired. There is also evidence of pensions being offered to public sector workers throughout history.
Public Sector Pension Plans
The first corporate pension in the U.S. was established by the American Express Company in 1875. Prior to that, most companies were small or family-run businesses. The plan applied to workers who had been with the company for 20 years of service, had reached age 60, and had been recommended for retirement by a manager and approved by a committee along with the board of directors. Workers who made it received half of their annual salary in retirement, up to a maximum of $500, according to the Bureau of Labor Statistics.
Banking and railroad companies were among the first to offer pensions to their employees. But by the turn of the 20th century, several large corporations began to grow and offer pensions. These included Standard Oil, US Steel, AT&T, Eastman Kodak, Goodyear, and General Electric, all of which had adopted pension plans before 1930. Manufacturing companies were the last to adopt the new retirement plans. The Internal Revenue Act of 1921 helped to spur growth, by exempting contributions made to employee pensions from federal corporate income tax.
Labor unions in the 1940s became interested in pension plans and pushed to increase the benefits offered. By 1950, nearly 10 million Americans, or about 25 percent of the private sector workforce, had a pension. Ten years later in 1960, about half of the private sector workforce had one.
After a few pensions began to fail, the government-enacted Employee Retirement Income Security Act (ERISA) in 1974 made pension plans more secure by establishing legal participation, accountability, and disclosure requirements. Not to mention guidelines for vesting, limiting the vesting schedule to within 10 years or less. With ERISA came the Pension Benefit Guaranty Corporation, which insures employee benefits should a pension plan fail.
Pension Is a Defined Benefit Plan
This type of guaranteed pension came to be known as a defined benefits plan. Workers knew exactly how much they would get in retirement because it was a defined dollar amount or percentage of salary. This was something a pre-retiree could plan a life around, and workers who wanted to save extra dollars of their own could do so, but private investment accounts were supplemental to pension and Social Security benefits.
Defined benefit plans are very different from what came after: defined contribution plans. In defined contribution plans, including 401(k) plans, 403(b) plans, 457 plans, and Thrift Savings Plans, the employee makes the bulk of the contributions to the plan and directs the investments within. These plans entered the picture in the early 1980s, a tax-deferred gift to highly compensated employees who wanted to shelter more of their paycheck from taxes. But as they gained popularity, 401(k)s and other defined contribution options quickly surpassed the defined benefit pension as the plan of choice for large private sector companies.