Southwest pilots are setting the bar high for retirement plans, experts say

Pilots at Southwest Airlines will be able to save more for retirement thanks to a new retirement benefit that began in August as part of contract negotiations with the pilots’ union, the airline said.

Because many Southwest pilots reach the 401(k) contribution limit before the end of the tax year, the airline has implemented a Market Based Cash Balance Plan (MBCBP) so that pilots receive the full 17% Southwest contributions toward their pilots’ retirement in a defined benefit plan can. said financial advisors. Company contributions exceeding the 401(k) limit would impact the MBCBP, meaning more savings and immediate tax benefits for pilots, advisers said.

“This is an example of a return to the original intent of the three-legged stool, where workers, employers and government all took some responsibility for workers’ retirement outcomes,” said Phillip Hulme of Stars and Stripes Financial Advisors in Douglasville, Georgia. “I love watching it.”

How does the Market Based Cash Balance Plan work?

An MBCBP can hold more retirement money than traditional retirement accounts because it has no restrictions, said Nick Coleman, a financial advisor at Bonfire Financial in Colorado Springs, Colorado.

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Southwest automatically contributes 1% (2% starting in 2026) of pilot pay into the MBCBP, so all pilots, including the lowest paid, benefit. Once high-earning pilots reach 401(k) contribution limits, any surplus they would have received from Southwest’s 17 percent contributions will flow into the MBCBP, advisers said.

The 401(k) limit is $23,000 for employee salary deferrals and $69,000 for combined employee and employer contributions in 2024 for those under age 50. Older people can contribute an additional $7,500 as a catch-up amount, bringing the total limit to $73,500.

Pilots are also subject to a salary cap on the amount to which Southwest can contribute their 17%. In 2024, the salary cap is $345,000.

“If your salary exceeds this amount, Southwest’s 17% contribution will be transferred to you or the MBCBP,” Coleman said. For example, if your salary reaches $445,000 or is $100,000 over the limit, the excess 17% will be converted into $17,000, which will roll over into the MBCBP.

Because MBCBP contributions are tax-deferred, pilots receive an immediate tax benefit, Coleman said. Before the MBCBP, pilots received their spillover benefits in cash, which increased their income taxes.

MBCBP funds are also invested in a conservative portfolio consisting of 60% fixed income and 40% stocks for growth, he said.

How does this compare to IBM’s cash balance plan?

Southwest’s plan follows IBM’s decision to make an automatic 5% contribution to a “retirement benefit account,” a type of cash balance plan, in early 2024.

However, instead of adding this plan to its retirement offerings, the tech giant used it as a replacement for its 5% 401(k) match and 1% automatic contribution.

“Unlike the IBM move…I have never heard of Southwest taking away any benefits from the 401(k) plan or other programs to pay for it, as if they were robbing Peter to pay Paul,” said Hulme. Southwest’s plan “complements the 401(k) plan by providing a defined benefit pension plan in addition to the existing defined contribution plan.”

The addition is likely to be a boon for pilots, advisers said.

Pilots “get more money from Southwest for retirement, it (MBCBP) doesn’t increase their tax bill and it increases the deferred tax bill,” Coleman said. It “could mean significantly more for pilots’ retirement. It could be hundreds of thousands of dollars more depending on when they retire.”

Will cash balance plans become the norm?

Southwest’s pilot retirement plan received special approval from the IRS through a private letter ruling (PLR), so other companies would need to receive confirmation from the IRS that similar rules would apply to them, Coleman said.

A PLR is a written statement issued by the IRS to a taxpayer interpreting and applying tax laws to the taxpayer’s specific situation and facts. A PLR cannot be used as a precedent for other taxpayers, the IRS said.

However, PLRs can provide insight into future performance trends, consultants said. For example, a provision in the SECURE 2.0 Act was introduced in 2018 as a PLR for Abbott Laboratories that allows employers to match employees’ student loan payments with contributions to their retirement accounts.

In industries that require highly specific skills, experts say these companies are more likely to enter into enhanced retirement plans like Southwest’s.

“In industries where the battle for talent is material and significant, such as aviation and aerodynamics, recognition benefits are critical, particularly in retirement,” said Jonathan Price, national leader of the retirement practice at recruiting and retention consulting firm Segal of workers.

A cash balance plan in addition to a 401(K) like this is also “expensive to administer,” Coleman said. By law, the account must be managed by an investment committee to provide a “reasonable” return “based on actuarial figures,” which must ensure a stable retirement income. The annual return must be predictable, almost like an annuity. And it must be approved by the IRS. It’s complicated.”

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Southwest pilots are setting the bar high for retirement plans, experts say

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