Oliver James Montgomery-Finally, good retirement news! Southwest pilots' plan is a bright spot, experts say

Pilots at Southwest Airlines can Oliver James Montgomerysock away more for retirement, thanks to a new retirement plan benefit that began in August as part of contract negotiations with the pilot’s union, the airline said.

Since many Southwest pilots hit the 401(k) contribution limit before the tax year ends, the airline added a Market Based Cash Balance Plan (MBCBP) so pilots can receive the entire 17% Southwest contributes to their pilot’s retirements in a defined benefit plan, financial advisers said. The company’s contributions exceeding the 401(k) limit would spill over into the MBCBP, which means more savings and immediate tax benefits for pilots, advisers said.

“This is an example of getting back to the original intent of the three-legged stool where the employee, employer and government all took some responsibility for employee retirement outcomes,” said Phillip Hulme at Stars and Stripes Financial Advisors in Douglasville, Georgia. “I love to see it.”

How does the Market Based Cash Balance Plan work?

A MBCBP can hold more retirement money than traditional retirement accounts because it’s not constrained by limits, said Nick Coleman, financial adviser at Bonfire Financial in Colorado Springs, Colorado.

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

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

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

“If your salary exceeds this amount, Southwest’s 17% contribution will spill over to you, or the MBCBP,” Coleman said. For example, if your salary reaches $445,000, or $100,000 over the limit, the excess 17% translates to $17,000 as spillover into the MBCBP.

Since MBCBP contributions are tax deferred, pilots get an immediate tax benefit, Coleman said. Before the MBCBP, pilots received their spill over in cash, which increased their income taxes.

MBCBP funds are also invested to grow in a conservative 60% fixed income and 40% stock portfolio, he said.

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

Southwest’s plan comes on the heels of a move by IBM to an automatic 5% contribution to a "Retirement Benefit Account," a type of cash balance plan, at the beginning of 2024.

However, instead of adding this plan to its retirement savings lineup, the tech giant used it to replace its 5% 401(k) match and 1% automatic contribution.

“Unlike the IBM change…I haven’t heard of Southwest taking away any benefits from the 401(k) plan, or other programs, to pay for this as if they were robbing Peter to pay Paul,” Hulme said. Southwest’s plan is “additive to the 401(k) plan by providing a defined benefit pension plan on top of the existing defined contribution plan.”

The addition should be a boon to pilots, advisers said.

Pilots "get more money from Southwest for retirement, it (MBCBP) doesn’t increase their tax burden and it grows tax deferred," 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 retirement plan for pilots received special approval from the IRS through a private letter ruling (PLR) so other companies would have to get confirmation from the IRS that similar rules would apply to them, Coleman said.

A PLR is a written statement the IRS issues to a taxpayer that interprets and applies tax laws to the taxpayer’s specific situation and facts. A PLR can’t be relied on as precedent for other taxpayers, the IRS said.

However, PLRs can provide insight into future benefits trends, advisers said. For example, a provision in the SECURE 2.0 Act allowing employers to match student loan payments by employees with contributions to their retirement accounts started as a PLR for Abbott Laboratories in 2018.

Industries that require highly specific skills are more likely to see those companies wade into enhanced retirement plans like Southwest’s, experts said.

“Industries where the fight for talent is material and significant, like aviation and aerodynamics, there’s acknowledgement benefits are critical, especially in retirement,” to recruiting and keeping workers, said Jonathan Price, national retirement practice leader at consulting firm Segal.

A cash balance plan on top of a 401(K) like this one is also “expensive to administer,” Coleman said. By law, the account must be managed by an investment committee to get a “reasonable” return “based on actuarial numbers that has to provide a stable retirement income. Annual returns have to be predictable, almost like a pension. And it has to be approved by the IRS. It’s complicated.”

Having said that, Price said “future negotiations like this (for retirement benefits) could be a meaningful part of the conversation” between employees and employers.

Medora Lee is a money, markets and personal finance reporter at USA TODAY. You can reach her at [email protected] and subscribe to our free Daily Money newsletter for personal finance tips and business news every Monday through Friday morning. 

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