How exactly did retirement get so complicated?

We Millennials are the first generation to be both privileged enough to be able to retire some day and be forewarned about retirement in the 21st century.  What I mean by this is that we KNOW that no one is coming to the rescue. So it’s up to each and every one of us to get the job done.

So how exactly did we end up here. It is always useful to have some historical context to the current situation and to your actions. There are two reasons for this. (1) History does repeat itself. (2) Understanding where we came from leads us to more creatively think about the current situation.

What did retirement look like in the good old days?

Before the Depression

So without much ado, here it goes. For most of recorded human history retirement was pretty simple. It just didn’t happen. Some were lucky enough to have an extended family. Lucky because wars, famine and disease had profound effects on the even extended families and chance largely determined who would still be around in say 10, 20, or even 30 years. These lucky people would work until they no longer could, and then be looked after in their final days by their family.The ones that weren’t lucky, would work as long as they physically could, and then slide into abject poverty.

So in the good case you ended up with your extended family:

And in the bad case you were on your own:


Now I know that happy stick figures of extended families create warm and fuzzy feelings, but let’s not get ahead of ourselves. We all know the picture isn’t rosy today and it was definitely must worse before. I say definitely because old people were a drain on the family resources and we all know what happens when people feel their resources constrained. Even today, elder fraud is one of the fastest growing fraud categories, so it begs to question how nice are we really to our old people?

WWII and the Depression

So this was the situation in the USA until the great depression and WWII. These two events changed retirement dramatically. First, as the depression dragged on, not only were 25% of people out of a job but deflation also set in. Deflation squeezed companies, their ability to pay workers, and their ability to grow. Pretty soon people were hungry and desperate. We memorialized this moment in history with the FDR memorial in Washington DC. If you have never been, please stop by on your next visit. It’s not often in a movie, but it is powerful and riveting. And the quotes will stay with you forever.

Here are two quotes from this incredible memorial:

“No country, however rich, can afford the waste of its human resources. Demoralization caused by vast unemployment is our greatest extravagance. Morally, it is the greatest menace to our social order.”

“I see one-third of a nation ill-housed, ill-clad, ill-nourished.” “The test of our progress is not whether we add more to the abundance of those who have much; it is whether we provide enough for those who have too little.”

The Depression Changed the Face of Retirement

The New Deal

This suffering pushed through a great change in politics of the United States – The New Deal. We can probably debate for hours the benefits and problems with the New Deal, but that isn’t the subject of this post. The New Deal forever changed retirement because it introduced Social Security. Social Security is the guarantee by the federal government that no person in America should fall into abject poverty in old age. Social Security represents the collective belief of the people in the United States that if a person has worked their whole life and contributed to our society, then we will in turn help them when they are in their weakest moment.

This is the reason that Social Security will not be allowed to go away. If Social Security were to be repealed, it would represent a monumental shift in the beliefs of Americans. It would mean that we no longer believe that vulnerable people should be protected. Frankly, it would mean that instead of “E Pluribus Unum,” we now say “you’re on your own, pops.”

Now along with the New Deal came WWII. And during WWII, the men were drafted and sent overseas to fight the war. And this wasn’t today’s war. Over 16 million men served in the military. So many men served in the military that there weren’t enough workers to keep America going. So in came Rosie the Riveter:

Along with Rosie came a great many incentives to go to work. Including health care (a topic for another day) and retirement. Now the war ended, and when the men came back, they promptly kicked the women out. “Thanks Rosie, that was good, but now its time go back to where you belong.” Shameful, but not the subject of this post.

What did not go was the benefits provided to incentivize workers during the war years. As a result, Americans of the Greatest Generation suddenly had a largely secured retirement via company pensions. For some of my younger readers, pensions are guaranteed lifetime payouts which are comparable to your salary, i.e., you get to keep your salary even though you’re no longer working. The catch of course is that you need to put in 30-35 years of service.


Life was pretty good, particularly while the United States was virtually the only advanced economy not decimated by the ravages of war. But as is often the case when times are good, people tend to make promises they can’t keep. People also tend to under-save, both personally and, it turns out, professionally when they manage company finances.

So what companies did is they saved too little with respect to their future obligations. In essence, for example, they promised to pay out $100 in the future, but only saved something like $30. This was no problem as long as the money kept pouring in. The trouble is that modern medicine increased the lifespan of people, and the role of children in earning money (needing kids to work to farm) diminished. The effect of these was to (1) increase the number of retired people, effectively increasing the size of the promised payouts – say now $200 instead of 100, and (2) to reduce the number of workers.

As a proxy to see this problem, consider this data I pulled form the Social Security Administration:


This plot shows you the ratio of Workers/Retirees since 1950. This ratio tells you roughly how much the workers need to save to support today’s retirees. The fewer workers, the more money each worker needs to pony up for the retirees. Got it? Now the point I was making in the prior paragraph is that since 1950 the number of retirees has grown because the expected lifespan of a person has grown from roughly 67 to 78 years. At the same time the mean number of children per family has fallen from 2.3 to 1.9 (2 being the replacement rate).

Now before you blame the younger generations for not having enough babies consider this: In 1900 more children meant more hands to work the farm and more earnings for the family. In 2017 more children means more college educations to pay for. See the difference?

All of this had a profound effect on the retirement system (yes, it’s now a system pension + Social Security). Turns out that since the royal WE didn’t save enough, things needed to change. But before this, of course we needed a well-intentioned but poorly thought out fix to the tax code.

Enter the 401k and Retirement in the 21st Century

Enter line number 401(k) in the year 1978. Here Congress decided it would be a good idea to amend the tax code to allow executives to defer compensation from bonuses and stock. What Congress didn’t consider is that some smart people at various companies would realize this can be done by workers as well. And that it would be cheaper to push workers to save than to save uniformly for all workers. Enter the age of tax deferred accounts. And that is exactly what happened.

Today fewer than 4% of workers have a pension plan through their company. In contrast in 1980 more than 60% had such a plan (at least according to CNN Money).

Now the good news is that at least people have access to savings vehicles. 100% of workers have access to IRAs, Individual Retirement Accounts, which as of 2017 allow each person to contribute $5,500/yr. This money is tax deferred which means you do not pay taxes today, but you do pay taxes when you retire.

65% of workers have access to a 401(k) which is again a tax deferred account but with a much larger yearly maximum of $18,000. If you have a sufficiently generous employer then your 401(k) plan may allow you to do after-tax deductions to reach the total IRS yearly limit of $54,000 in retirement accounts. All of this to say, you have tools.

Now of course, contributing to your own retirement account is a far cry from having a defined pension. Strictly speaking with a pension you did not need to save for retirement. You simply continued to get your paycheck! How nice would this be? It’s easy to see how a pension plan with 100% worker coverage would add several points to the GDP since workers could spend their money instead of saving. But of course no such plan exists and probably more importantly, no such plan can be paid for in its entirety.

So in a nutshell, this is how we ended up where we are. We started the last century with great hope that retirement would be changed by the generosity of our society and employers. When the employers realized that it was hard to keep such long promises, a convenient tweak in the tax code created a new vehicle for retirement saving and those pension promises largely ended within a decade or two.

Of course since the new approach is based on the tax code, there are inherent limitations. To maximize savings, we must carefully navigate these options. And this, my dear reader, will be the subject of my next post.

4 thoughts on “How exactly did retirement get so complicated?

  1. Sadly, I see a lot of people depending on just Social Security. Although they don’t retire to abject poverty, they do seem to retire to a subsistence-level existence. Food, water, and shelter, but not much else. Those who have kids that can afford to help them do a little better. It seems to me that those who have other means (such as a well-funded IRA) are in the minority.

    1. You’re right and it’s very unfortunate. I do think that young people now, millennials and beyond are in a very unique situation. We both know that we need to fund retirement and we have the ability to do so on a relative historical basis.

  2. All true and well stated. One thing that you may not know that I as a Boomer am all too familiar with is that while there were 60% pension covered workers in 1980 that by 1985 the number was cut drastically. My pension was eliminated in 1985 along with the majority of pensions that were still in effect so millennials are not really in a world that different than Gen X or Boomers. In fact you have an advantage, while the 401k plan was legal in 1978 few companies installed them until 1985 or later. In my company we had no 401k option until 1988 meaning I didn’t have any retirement plan until I had been working for ten years while millennials can participate from day one. In my case it was early enough in my career that even without it I could easily save aggressively and retire early with a high standard of living that will never need Social Security. Millennials do suffer from some serious issues like salary compression and potentially sluggish equity returns for the next couple of decades though which have to concern them looking ahead. Great read!

    1. Hi Steveark, thanks for your great comment and your perspective. I appreciate that you shared your story. I’m also glad to hear that you had an early enough warning. Millennials do face some significant issues. Salary compression coupled with rising cost of living (housing) is definitely something that prevents healthy retirement savings. But at least we were warned loud and clear!

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