One thing that anyone active in a tax practice understands is that you must adapt to an ever-changing environment. One huge change over the last century is how the average worker’s retirement is funded while at the same time the life expectancy has significantly increased. The combination of these two elements is a major financial planning topic for the CPA to address with all of their clients because a large majority are reaching retirement age without adequate savings.
When this country was founded and the most common way of life revolved around the family farm and agriculture when 90% of the work force was agricultural, retirement meant living with the family members who had taken over the farm. As we read the accounts of those years, we come to understand that life was hard and life expectancy was not very long.
In 1776 life expectancy was 35 years. In 1900, just more than a century later, the life expectancy had risen to 49 years and only 38% of the US work force was agricultural. By comparison in 1960 only 8.3% of the US work force was agricultural and medical science was beginning to show significant strides as life expectancy was recorded at 69.8 years. Today, in the US the average life expectancy is 78.7 years (women’s life expectancy is approximately 80 years).
Parallel to this rise in life expectancy was a transformation of how the average worker’s retirement was funded. As America became an industrialized country and the work force moved from the farm to the factory, companies began to provide lifetime pensions to their workers. As the medical technology advanced through the 1900s so did the financial burden of providing this lifetime pension. By the end of the last century, it seems that only a small percentage of the largest corporations and governmental entities were still providing a lifetime pension.
In an article titled A Brief History of Retirement In America (Part 1) by MELP on October 18, 2009 (http://www.thenexthill.com/a-brief-history-of-retirement-in-america-part-1.htm) the author states, “nearly everyone in America over the age of 40 obsesses about retirement. It is the epilogue of the American Dream. A secure retirement is the end mark of a life well lead, even something of a status symbol… But retirement wasn’t always the stuff of sweet daydreams. 150 years ago, almost no one thought of retiring. In fact, the idea of retirement as something we should all aspire to has only been around for about 60 years.”
As the US moved from an agriculturally based work force to people working in factories, the funding of retirement changed. As factory owners sought to maintain a highly productive work force, they implemented incentives for older workers to retire and provided limited funding. By about 1920, as much as 40 plus percent of the white males over 60 were retired. Then Congress enters the mix by passing The Social Security Act of 1935. It was originally framed by Congress as a way to deal with large levels of unemployment coming out of the depression with a permanent benefit that allowed a small replacement to the wages the worker previously earned. Although, the first versions of the bill provided for the benefit to start at age 70, Congress voted on age 65. Think back to 1840, only 4% of the US population was over age 60 and by 1935 this had only grown to just over 6%. In 2010 due to increased life expectancy and the baby boom generation’s aging, this segment accounts for approximately 12.5% of the total US population.
In 1945 an estimated 17% of those retiring from a private sector job had a pension. The next thirty years saw a tremendous growth in the number of companies providing a pension. In 1975 it was estimated that as much as 55% of the private sector provided pensions for their retiring employees. So once again Congress enters and passed Employee Retirement Income Security Act (ERISA) and created the Pension Benefit Guaranty Corporation to ensure that employees received their pensions if their plans went bankrupt.
The long-term result of ERISA was that corporate America began to recognize that they could not fund the pensions promised to workers. Those looking back and analyzing this lay the blame in part to the extended life expectancy but also that ERISA mandated a survivor’s benefit that further extended the cost of providing a pension.
In Tax Reform Act of 1978, the tax code saw the introduction of the 401k plan. Section 401 provided for a qualified savings plan. This was the birth of the 401k as we know it today. Over the next few decades the responsibility of funding an individual’s retirement was shifted to the retiree as companies quickly moved from defined benefit plans to defined contribution plans with an increasing emphasis of the employee self funding via the 401k plans. In 1975 over 70% of the workers in the private sector who had a retirement benefit were covered by a defined benefit plan whereas by 2006, over 75% of the workers in the private sector covered by a retirement plan were covered by a defined contribution plan.
But some will ask, what about Social Security? The fact is that Social Security was never intended to be the sole source of a person’s retirement. It was meant to be a supplement to that company pension. On the Social Security’s Web site (http://ssa.gov/pubs/10024.html) it says: “Social Security was never meant to be the only source of income for people when they retire. Social Security replaces about 40 percent of an average wage earner’s income after retiring.”
However over the past few decades many have reached retirement with very little in savings and no pension. According to (http://www.retirement-income.net/blog/retirement-savings/average-retirement-savings-all-measurements-lead-to-the-same-conclusion/) published: August 14th, 2008, “The ‘baby boomer generation’ are those people between 45 and 62 years of age (as of 2008). This generation has saved on the average retirement savings of $38,000, excluding pensions, homes, and social security. However, “baby boomers” with qualified retirement plans have an average retirement savings of $88,000. The $88,000 of average retirement savings will generate an annual retirement income of about $5,000 yearly.” The online article continues to say: “It’s estimated that the average projected post-retirement income replacement needed among employees of large U.S. employers is 126% of final pay, a level only about 19 percent of employees are expected to satisfy, according to a Hewitt Associates report released July 1. If we assume that the average person earns $40,000 annually, they would need about $50,000 in retirement income, requiring an average retirement savings of $833,000 (not taking into account any social security income). In fact, according to the report, Total Retirement Income at Large Companies: the Real Deal 2008, about 67 percent of the more than 1.8 million employees of 72 large U.S. employers tracked in the study are expected to have accumulated less than 80 percent of their projected needs at age 65.”
In another online article posted (http://20somethingfinance.com/average-retirement-savings/) by G.E. Miller on October 19, 2009, The Shockingly Low Amount of Retirement Savings per American: “According to the Employee Benefits Research Institute’s (EBRI) 2009 Retirement Confidence Survey, 53% of workers in the U.S. have less than $25,000 in total savings and investments. The typical American household (headed by a 43 year old) has just over $18,000 in savings!”
According to the 2011 Retirement Confidence Survey, Employee Benefit Research Institute and Mathew Greenwald & Associates, “retirees say Social Security makes up a major share of their income (68%). However, EBRI research found in 2009 that 60% of those 65 or older received at least 75% of their income from Social Security.”
The EBRI study further states: “The age at which workers expect to retire is gradually rising. In 1991, half of workers planned to retire before age 65, compared with 23 percent in 2011. …. Seventy-four percent of workers now say they plan to work for pay after they retire. Almost all retirees (90%) who worked in retirement name at least one financial reason for doing so, such as wanting money to buy extras (72%), a decrease in the value of their savings or investments (62 percent), needing money to make ends meet (59%), and keeping health insurance or other benefits (40%). Many workers are also planning to rely on income from employment to support them in retirement. Three-quarters of workers say that employment will provide them (and their spouse) with a major (24%) or minor (53%) source of income in retirement (77% total, up from 68% in 2001 but statistically equivalent to 79% in 2009 and 77% in 2010).”
This stark reality seems to be the bi-product of the two factors mentioned above, the change from companies providing lifetime pensions (defined benefit plans) and the extended life expectancy afforded by advances in medical technology. As CPAs and tax professionals, we need to understand the stark change that has occurred in the retirement landscape and we must be active in this conversation with our clients of all ages. Financial planning is a service your clients need from you.
Jerry Love, CPA, is the sole owner of Jerry Love CPA, LLC in Abilene, TX. Contact him at
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