History Pensions

The development of private pensions and Social Security in the United States parallels their development internationally. Pensions evolved through American history in ways resulting in closely intertwined private and public pension systems.

As in other parts of the world, pensions initially were provided to those in financial need or as gratuities. In colonial America, the Presbyterian and Moravian churches paid pensions to their ministers' widows and orphans, while the new U.S. government granted annuities to Revolutionary War veterans for their service to the country.

The view of pensions as gratuities had not changed when Congress passed legislation in 1862 to provide annuities to Union soldiers disabled in the Civil War. This program grew to include widows and orphans, and the definition of disability was liberalized over the years. During its peak years in the mid-1890s, the Civil War pension program functioned much like a social insurance program and consumed 43 percent of federal expenditures.

After the Civil War, pensions gradually transformed from ad hoc payments because of financial need to formal plans designed to retain valued employees and ease superannuated employees off the job. Modern pension plans first appeared in the railroad industry. American Express, then a railroad freight company, established the first formal U.S. plan in 1875. Pension plans spread to other railroad companies, then to other industries. The federal and state governments followed suit, and the federal government established a plan for its employees in 1920. By then over three hundred plans covered 15 percent of the U.S. work force.

During the 1920s, businesses realized they needed sounder financing of an increasingly expensive benefit they had funded on a pay-as-you go basis. Insurance companies managed much of the growing private system's assets, providing annuities to eligible workers using employer funds. After a period of growth that lasted through the 1940s, insurance company provision of group pension annuities to employers declined due to rising costs, the advent of Social Security, and the rise of union involvement in pensions.

Private pensions enjoyed tax-favored status early in their development. By the end of 1921, companies could deduct pension plan contributions and escape paying tax on the pension trust investment income. When it became apparent in the late 1930s that pensions primarily benefited higher-paid employees, Congress instituted requirements for plans to maintain tax-favored status. The Revenue Act of 1942 required plans to include a minimum percentage of employees and to provide benefits that did not disproportionately favor the highly paid. It also enacted the first funding requirements for pensions.

Social Security has also played a major role in the development of U.S. private pensions. The Great Depression brought with it the realization that a federal response was necessary to address the poverty suffered by 50 percent of the elderly population. In 1934, President Franklin D. Roosevelt formed the Committee on Economic Security, whose recommendations resulted in Social Security's passage in 1935. The new program provided retirement income to workers beginning at age sixty-five. Amendments to Social Security in 1939 added spouse and dependents' benefits. Later amendments increased benefits, then automatic cost-of-living adjustments were added to benefits in payment status in 1972.

The number of pension plans grew dramatically during World War II. High income taxes and war-time limits on wages (but not on future pension benefits) made pensions more attractive as a form of compensation. By 1945, pensions covered 6.5 million employees up from 2 million in 1938. Other developments include the rise of union pensions for blue-collar workers. A 1949 Supreme Court decision facilitated this trend (Inland Steel Company vs. National Labor Relations Board), stating that pensions were a mandatory subject of bargaining. By 1960, pension coverage of the private work force was 40 percent, and pension participation increased to 45 percent by 1970.

As the private pension system matured, gaps appeared. Lack of vesting requirements, chronic underfunding, and financial self-dealing resulted in a disproportionate number of pension participants retiring without benefits. After Congress enacted several modest measures to resolve some of these problems, it passed the comprehensive Employee Retirement Income Security Act (ERISA) in 1974. ERISA established minimum participation, as well as vesting requirements, fiduciary standards, break-in-service rules, survivor benefit requirements, and an insurance program for defined benefit pensions.

Legislative efforts to ensure that workers receive the pensions promised from their company plans have continued since 1974. Congress enacted legislation making it more likely that lower-paid workers will receive benefits from their pensions; expanding benefit rights of widowed and divorced spouses; shortening vesting periods; limiting the effect of taking Social Security into account when calculating the pension amount; and requiring that older workers be included in pensions and that their benefits continue to grow.