Thanks to a recently introduced retirement benefit initiated during contract talks with the pilots’ union, Southwest Airlines pilots can now save more for their future.

Since many pilots at Southwest reach their 401(k) contribution limits prior to the end of the tax year, the airline introduced a Market Based Cash Balance Plan (MBCBP), allowing pilots to receive the full 17% contribution from Southwest into a defined benefit plan, according to financial experts. Contributions from Southwest that exceed the 401(k) limit will go into the MBCBP, facilitating greater savings and immediate tax advantages for the pilots, the advisors added.

“This reflects a return to the original concept of the three-legged stool where employees, employers, and the government all share in the responsibility for retirement outcomes,” stated Phillip Hulme from Stars and Stripes Financial Advisors in Douglasville, Georgia. “It’s wonderful to see.”

Understanding the Market Based Cash Balance Plan

The MBCBP can hold larger amounts of retirement savings than traditional accounts as it isn’t limited by typical restrictions, explained Nick Coleman, a financial advisor at Bonfire Financial in Colorado Springs, Colorado.

Southwest contributes 1% (increasing to 2% starting in 2026) of a pilot’s salary to the MBCBP automatically, ensuring that even the lowest paid pilots gain benefits. Once higher-earning pilots reach the 401(k) contribution limits, any surplus from Southwest’s 17% contributions will be allocated to the MBCBP, according to experts.

As of 2024, the 401(k) limit stands at $23,000 for employee salary deferrals and $69,000 for the total employee and employer contributions for individuals under 50 years old. Those over 50 can contribute an additional $7,500, bringing the overall limit to $73,500.

There is also a salary limit that determines how much Southwest can contribute their 17% on. For 2024, this salary cap is set at $345,000.

“If a pilot’s salary goes beyond this threshold, Southwest’s 17% contribution will then go to the MBCBP instead,” Coleman clarified. For instance, if a pilot earns $445,000, which exceeds the cap by $100,000, the additional 17% would result in $17,000 being redirected to the MBCBP.

As contributions to the MBCBP are tax-deferred, pilots experience immediate tax benefits, Coleman pointed out. Previously, pilots received any excess in cash, which raised their taxable income.

Funds in the MBCBP are also invested conservatively—with 60% in fixed income and 40% in stocks, he explained.

How does this differ from IBM’s cash balance plan?

Southwest’s recent plan follows IBM’s announcement of a 5% automatic contribution to a “Retirement Benefit Account,” a form of cash balance plan, set to take effect in early 2024.

Contrarily, IBM replaced its existing 5% 401(k) match and 1% automatic contribution with this new plan instead of adding to their retirement offerings.

“In contrast to IBM’s approach…there’s been no indication that Southwest has withdrawn any benefits from the 401(k) plan or any other programs to finance this new plan,” commented Hulme. He further noted that Southwest’s approach is “an addition to the 401(k) plan by creating a defined benefit pension plan alongside the existing defined contribution plan.”

This addition is expected to significantly benefit pilots, according to financial advisors.

Pilots will “receive more retirement funds from Southwest without an increase in their tax obligations, and it will grow tax-deferred,” Coleman noted. This could translate into substantial increases in their retirement savings, which may reach hundreds of thousands of dollars more, depending on their retirement timing.

Will cash balance plans become common practice?

The retirement initiative for pilots at Southwest has received special IRS approval through a private letter ruling (PLR), meaning other companies need to secure similar confirmation from the IRS for such plans.

A PLR is a written statement issued by the IRS that interprets and applies tax laws regarding a taxpayer’s unique circumstances. However, it is not a precedent for other taxpayers, as clarified by the IRS.

Nevertheless, PLRs can shed light on future trends in employee benefits, experts believe. For example, a provision in the SECURE 2.0 Act that allows employers to match employee student loan payments with retirement account contributions originally stemmed from a PLR for Abbott Laboratories dating back to 2018.

Industries requiring specialized skills may increasingly adopt retirement plans like that of Southwest, experts suggest.

<p“In fields where talent competition is fierce, such as aviation, there is a recognition that benefits are essential to attract and retain employees,” explained Jonathan Price, national retirement practice leader at the consulting firm Segal.

However, implementing a cash balance plan alongside a 401(k), like Southwest’s, can also be “costly to manage,” Coleman remarked.

According to the law, an investment committee is required to oversee the account to ensure a “reasonable” return that aligns with actuarial standards, which must guarantee a consistent retirement income. The annual returns should be stable and similar to those of a pension, and this plan must receive IRS approval. It’s a complex process.

Despite this complexity, Price mentioned that “upcoming discussions regarding retirement benefits could play a significant role in the dialogue” between workers and employers.