Retirement income system in the 2000s

The various government-sponsored, employer-sponsored, and private retirement savings programs that have enabled US workers to retire from full-time employment in their senior years, typically starting around age sixty-five

The retirement income system of the United States faced great challenges in the 2000s, due in large part to two economic recessions. The first recession, which occurred in 2001, was relatively mild, but the latter one, which began in late 2007, caused great harm to the incomes of millions of Americans, who had considerable sums invested in the stock market through defined-contribution retirement plans. As millions lost their jobs during the latter recession, which has come to be known as the Great Recession, the Social Security retirement system, funded primarily by dedicated payroll taxes, also saw its revenues fall.

Between 2000 and 2009, the retirement income system in the United States found itself entering a moment of crisis. Social Security, which typically constitutes the largest portion of an individual’s retirement income, was reaching a point of insolvency. Pensions, also known as defined-benefit retirement plans, were fast disappearing from employers’ benefits packages. Defined-contribution plans like 401(k)s, which are tied to the stock market, were demonstrating in the economic downturns that they could not always provide true financial security for many US workers. By 2009, the two economic recessions of the decade—coupled with the impending retirement of the baby boom generation (typically defined as Americans born between the years 1946 and 1964)—suggested to many observers that the retirement income system was overburdened, inefficient, and unable to provide the kind of retirement security most Americans had come to expect throughout most of the twentieth century.

Social Security

Social Security was established to grant pension benefits to elderly and unemployed Americans who had suffered greatly during the Great Depression of the 1930s. The Social Security Act of 1935 was extended many times in subsequent decades to include benefits for the disabled and to provide health care to senior citizens under the Medicare provisions signed into law in 1965. Both Medicare and Social Security are supported by dedicated payroll taxes paid by both employers and employees. These tax revenues are then placed into one of several Social Security trust funds, which are used to pay beneficiaries of the program. Whatever money is left over after paying out benefits is then invested in US Treasury securities, the debt-financing tools of the US federal government. Social Security recipients receive a monthly stipend that has been calculated for each individual based on salary and length of participation in the program (via payroll taxes).

In the decades since Social Security’s establishment, the benefits paid out to recipients have needed to be periodically adjusted upward against inflation. Social Security’s tax revenues have also periodically had to be increased in order to pay promised benefits to all the workers eligible for the program. (In 2012, 94 percent of all US workers were eligible for the program, and nine out of ten senior citizens received income from Social Security.) Prior to the economic crisis of the 2000s, the last time the program faced serious budget shortfalls was in 1983, when President Ronald Reagan and Democratic leaders in Congress made changes to the program that shored up its finances for roughly another half century. In the 2000s, however, Republican and Democratic leaders could not find a consensus on how to fix Social Security, despite the fact that the program’s problems were apparent. In 2001, during the first recession of the decade, the Social Security Board of Trustees announced that the trust fund would face funding shortfalls by 2038. Social Security’s prospects did not improve during the decade’s weak economic recovery: in 2005, the board announced that Social Security contributions would peak by 2008 and decline thereafter before beginning to pay out more in benefits than it received in payroll taxes by 2018.

The Great Recession, which began in late 2007, was even more damaging to Social Security’s finances. Unemployment was far more widespread, and underemployment—defined as the part of the population working part time but would rather work full time—became an acute problem for the US economy. With fewer people working or working full time, less money was going into Social Security, making the problems facing the program that much worse. In 2012, President Barack Obama’s administration reported that Social Security’s trust fund would run out by 2033, three years sooner than reported just a year earlier; Medicare’s hospital fund was estimated to run out in 2024; and Social Security’s disability insurance was estimated to run out in 2016. Without the trust funds, tax revenues—coming through the Social Security payroll tax—could only pay for just 75 percent of promised benefits.

Pensions

A longtime part of a US worker’s employee benefits package has been the defined-benefit retirement plan, better known as a pension. Like Social Security, it provides a monthly payment for life to retirees but is administered and distributed by an individual’s employer, not the US government. Unlike Social Security, most pension checks are not adjusted to rise with inflation. Employer-sponsored pensions go back to 1875, when the American Express Company began administering one for its retirees. In the early part of the twentieth century, many US employers, encouraged by the tax incentives such retirement plans brought them, began offering pensions to their workers. By 1960, nearly 30 percent of the working population—about twenty-three million people—had some kind of private pension through their employers. In 1983, 62 percent of US workers had a pension plan through their companies.

In the early 1980s, employers began moving away from providing pensions, due in part to the fact that many had not been fully funded in the first place, but also because the US government had made it more desirable from a tax perspective for companies to offer employees a defined-contribution plan like a 401(k) instead. In the 2000s, fewer companies offered traditional pensions, and those that did were trying to phase them out. Five notable major US companies (General Motors, American Airlines, AT&T, Verizon, and General Electric) reduced or eliminated their traditional pensions altogether.

In 2006, the Pension Protection Act was passed. The law closed loopholes in earlier laws that had allowed corporations to underfund their pension programs; it also permitted employers to enroll their workers automatically in defined-contribution plans, while at the same time granting those workers even more control over their retirement investments.

IRAs, 401(k)s, and 403(b)s

As of 2007, 63 percent of employees in the United States had some kind of defined-contribution plan, such as a 401(k) or, in the case of nonprofits, a 403(b). These programs, named for their sections in the tax code, are similar to individual retirement accounts (IRAs), which allow workers to place a portion of their pre-tax income into retirement accounts made up of stocks, bonds, and other such investments. Many US companies, though not all—and fewer during the 2000s—offer their employees matching contributions, up to a certain percentage, to make the plans more appealing. Unlike traditional pensions, a worker may receive a lump sum of money, instead of a monthly stipend, upon retirement. The distribution amount depends entirely on how wisely individuals have invested and/or if they have retired at a point in the economic cycle when their investments are doing well.

In the 2000s, the weaknesses of defined-contribution plans became apparent to many Americans who had retired or were on the cusp of retirement. Few US workers were as skilled as professional retirement planners (who manage pensions, for example) in choosing the right investments. Following the collapse of the stock market in 2008, IRAs that invested heavily in stocks saw their values decrease considerably. This decrease in value affected a large swath of the US population: roughly 60 percent of households were headed by someone who was nearing retirement age and had money in some kind of defined-contribution plan. Moreover, personal savings was at an all-time low because of declining home prices, stagnant salaries, rising costs of health care and education, and widespread unemployment. Less than a quarter of households headed by individuals aged sixty to sixty-two had what they needed in defined-contribution accounts in order to maintain their current standard of living in retirement.

Impact

Many economists believe that the economy recessions the nation faced in the 2000s emphasized the enormous problems of the retirement income system in the United States—problems that, left unattended, would only grow worse in the coming decade as millions of baby boomers began to retire. Even if Social Security’s finances were repaired in relatively short order, the program typically provides for only 40 percent of a retiree’s pre-retirement income. The rest has tended to come from an individual’s own money, whether through a pension, a defined-contribution plan like a 401(k), or personal savings built up over a lifetime. Retirement plan managers generally agree that individuals need about 85 percent of their pre-retirement income in retirement. Unfortunately, only half of US households can expect to receive money from a pension upon retirement, and 401(k)-type plans have not provided the security of an expected monthly stipend when a stock market downturn, like the ones endured in the 2000s, devalue retirement accounts.

Just as great a threat facing the retirement income system, observers say, is the US debt crisis, in which the federal government has been borrowing enormous sums of money from other nations in order to finance its current and future obligations. Left unchecked, the US government would not be able to borrow money at the same low interest rates it previously enjoyed. If this were to occur, the government would not only be unable to pay retirement and health care benefits for Social Security and Medicare, but it would also be less likely to pay future retirees the promised benefits they expect to receive by paying their payroll taxes for these programs.

Bibliography

Costa, Dora L. The Evolution of Retirement: An American Economic History, 1880–1990. Chicago: U of Chicago P, 1998. Print. Provides a complete overview of how the US retirement system developed into its modern form.

Jason, Julie. The AARP Retirement Survival Guide: How to Make Smart Financial Decisions in Good Times and Bad. New York: Sterling, 2009. Print. Written by a personal money manager. Provides insight into the ways individuals can create their own “personal pensions” and get the most out of the retirement income system in the United States.

Landis, Andy. Social Security: The Inside Story: An Expert Explains Your Rights and Benefits. Menlo Park: Crisp Learning, 2011. Print. Written by a former representative of the Social Security Administration. Uses clear language to describe to readers how to maximize the benefits they are entitled to as workers who have paid into the Social Security system.

Schieber, Sylvester J. The Predictable Surprise: The Unraveling of the US Retirement System. New York: Oxford UP, 2012. Print. Presents a detailed overview of the problems facing the US retirement system, a history of how the nation reached this point, and a blueprint for a way to provide a more secure retirement for every American.

Weisman, Steve. The Truth about Protecting Your IRAs and 401(k)s. Upper Saddle River: FT, 2009. Print. Details the best ways for investors to maximize earnings from their defined-contribution plans, while protecting their savings from unnecessary tax burdens.