Southwest pilots set the bar high for pension plans, experts say

On By Littum

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Southwest Airlines pilots can sop more into retirement thanks to a new pension plan that began in August as part of the contract negotiations with the pilot’s unionsaid the airline.

Since many Southwest pilots have reached the 401(k) contribution limit before the end of the tax year, the airline added a market-based cash balance plan (MBCBP) so pilots can receive a full 17% Southwest contribution to their pilot’s retirement in a defined benefit plan, financial advisers said. Company contributions that exceed the 401(k) limit would trickle down to MBCBP, meaning more savings and immediate tax benefits for pilots, advisers said.

“This is an example of returning 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 of Stars and Stripes Financial Advisors in Douglasville, Georgia. “I love to see it.”

How does the market-based cash balance plan work?

An MBCBP can have more retirement money than traditional retirement accounts because it’s not limited by limits, said Nick Coleman, a financial advisor at Bonfire Financial in Colorado Springs, Colo.

Southwest automatically contributes 1% (2% starting in 2026) of a pilot’s salary to the MBBCBP, so that all pilots, including the lowest paid, benefit. Once high-earning pilots reach the 401(k) contribution limit, any profits they would have received from Southwest’s 17% contribution go into the MBBCBP, 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. Older people can contribute an additional $7,500 as a catch-up, bringing the total limit to $73,500.

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

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

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

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

How does this compare to IBM’s cash plan?

Southwest’s plan comes on the heels of a move by IBM for an automatic 5% contribution to a “Retirement Benefit Account,” a type of cash balance plan, in early 2024.

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

“Unlike the IBM change … I have not heard of Southwest taking any benefits from the 401(k) plan or other programs to pay for this, as if they are robbing Peter to pay Paul,” said Hulme. Southwest’s plan is “additive to the 401(k) plan by offering a defined benefit 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 increases tax-deferred,” Coleman said. That “could mean significantly more to (the 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 that other companies would get confirmation from the IRS that similar rules would apply to them, Coleman said.

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

However, PLRs can provide insight into future benefit trends, advisers said. For example, a provision in the SECURE 2.0 Act that allows employers to match student loan payments from employees with contributions to their retirement accounts started as a government loan 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 battle for talent is material and significant, like aviation and aerodynamics, there are recognition benefits that are critical, especially at retirement,” to recruit and retain workers, said Jonathan Price, national retirement leader at consulting firm Segal.

A cash balance plan on top of a 401(K) like this 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 should provide a stable retirement income. Annual returns must be predictable, almost like a pension. And it must be approved by the IRS. It’s complicated .”

That said, Price said “future negotiations like this (about pension benefits) could be a meaningful part of the conversation” between employees and employers.

Medora Lee is USA TODAY’s money, markets and personal finance reporter. 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.