Southwest Pilots’ Retirement Plan Shines, Offering Rare Good News!

Southwest Airlines pilots have a new avenue to boost their retirement savings, following a recent enhancement to their retirement plan. This update, which took effect in August, is a result of negotiations with the pilots’ union, according to the airline.

Many pilots at Southwest typically reach the 401(k) contribution ceiling before the year is out. In response, the airline has introduced a Market Based Cash Balance Plan (MBCBP), allowing pilots to fully benefit from the 17% retirement contribution that Southwest earmarks for them under a defined benefit scheme, say financial experts. Any contributions that surpass the 401(k) caps will now flow into the MBCBP, offering pilots additional savings and immediate tax advantages, the advisors noted.

“It’s refreshing to see a return to the traditional three-pronged approach to retirement planning, involving the employee, employer, and government,” remarked Phillip Hulme from Stars and Stripes Financial Advisors in Douglasville, Georgia. “It’s a positive development.”

Understanding the Market Based Cash Balance Plan

The MBCBP isn’t limited by the typical restrictions of traditional retirement accounts, allowing it to hold more funds, explained Nick Coleman, a financial adviser at Bonfire Financial in Colorado Springs, Colorado.

Southwest contributes 1% of a pilot’s salary to the MBCBP, a figure that will increase to 2% by 2026, ensuring all pilots, even those on the lower end of the pay scale, gain from this plan. Once pilots hit the maximum allowable 401(k) contributions, any additional contributions from the airline’s 17% will be diverted into the MBCBP, Coleman added.

The contribution limit for a 401(k) in 2024 stands at $23,000 for personal deferrals, and $69,000 for combined employee and employer contributions for individuals under 50. Those over 50 can contribute an additional $7,500, raising their limit to $76,500.

There’s also a cap on the salary amount that qualifies for Southwest’s 17% contribution. In 2024, this cap is $345,000. “If your salary exceeds this, the additional 17% from Southwest will transfer into your MBCBP,” Coleman explained. For instance, if a pilot earns $445,000, which is $100,000 over the cap, the excess 17% or $17,000, would go into the MBCBP.

Contributions to the MBCBP are tax-deferred, providing pilots with significant tax relief immediately. Previously, excess contributions were paid in cash, which bumped up their taxable income, according to Coleman. Additionally, funds within the MBCBP are conservatively invested, with a mix of 60% in fixed income and 40% in stocks.

Comparison with IBM’s Cash Balance Plan

Southwest’s new plan follows IBM’s introduction of a cash balance plan called the “Retirement Benefit Account” in early 2024, which also includes an automatic 5% contribution. However, IBM’s plan replaces its existing 5% 401(k) match and 1% automatic contribution, unlike Southwest’s addition, which supplements the existing benefits.

“What sets this apart from IBM’s changes is that there’s no reduction in other benefits to fund this new plan,” Hulme stated. “It’s a supplementary benefit over the existing 401(k), enhancing the existing defined contribution with a defined benefit pension plan.”

This enhancement should significantly benefit Southwest pilots, according to financial advisers. “It means more retirement funds from Southwest, without raising taxes and allowing for tax-deferred growth,” Coleman commented. “This could translate into substantially more retirement savings, potentially adding hundreds of thousands of dollars depending on the pilot’s retirement timeline.”

Will Cash Balance Plans Become More Common?

Southwest managed to secure this unique retirement plan for its pilots following a specific approval from the IRS via a private letter ruling (PLR), Coleman mentioned. Other companies would need similar IRS approval for their plans, he added.

A PLR is a tailored statement from the IRS to a taxpayer, applying tax laws to their particular situation, though it cannot set a precedent for other taxpayers, according to the IRS.

Such rulings could hint at future trends in benefits, advisors suggest. For instance, the provision in the SECURE 2.0 Act that allows matching student loan payments with retirement contributions was initially a PLR for Abbott Laboratories in 2018.

Companies requiring specialized skills, like those in aviation, are more likely to explore enhanced retirement plans, noted Jonathan Price, a leader at Segal consulting firm. “In industries where there’s a fierce competition for talent, offering substantial retirement benefits is crucial for attracting and retaining employees,” he said.

However, administering a cash balance plan like this can be costly, as it requires management by an investment committee to ensure stable, actuarially reasonable returns, Coleman explained. “But these kinds of discussions about retirement benefits are likely to become a significant part of employment negotiations in the future,” Price added.