Airline Pilots' New Defined Benefit (DB) Pension Plans
The latest evidence of a DB comeback? (Well, no)
In 2023 and 2024, new defined benefit (DB) plans were established by some large, well-known corporations, prompting some to suggest that a pension comeback, exemplified by IBM re-opening its DB plan, may be accelerating. Do corporations finally realize that we are “fully four decades into the 401(k) experiment, and it is abundantly clear that these plans just can’t do the retirement job alone”?
Airline pilots have new DB plans, and (part of) the crowd is going wild
Pilot union negotiations in 2023 at Delta, United, American, and Southwest resulted in contracts requiring the airlines to establish new DB plans.1
This development triggered “so you’re telling me there’s a chance!” excitement in some quarters. The head of the National Institute on Retirement Security (NIRS), a public pension political advocacy group, in his second annual (?) DB-is-coming-back Forbes article,2 rejoiced “that the [Southwest] pilots were successful in improving their retirement benefits by negotiating a key new benefit that includes life income.” The title of an article in USA Today gushed, “Finally, good retirement news! Southwest pilots' plan is a bright spot, experts say,” and the experts indeed seem happy. As one put it:
“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…I love to see it.”
Hey fellas, cool your jets.
Like IBM’s plan, the new pilots’ plans are “cash balance plans”…
Pensions & Investments reports, “Southwest’s cash balance plan follows IBM’s implementation of a similar plan in January [2024].”
Cash balance plans are often referred to as “hybrid” plans, a cross between DB plans and defined contribution (DC) plans like 401(k)s.
While cash balance plans are legally classified as DB plans, they resemble DC plans in several ways. Unlike a traditional DB plan, where the promised benefit is expressed as a lifetime annuity starting at a defined age, often 65 (with benefit adjustments for different starting ages), a participant’s cash balance plan benefit is defined in terms of a notional account that looks like a DC plan account. Plan rules specify an annual pay credit analogous to a DC plan contribution and annual interest credits analogous to DC account earnings.
But as DB plans, cash balance plans must comply with ERISA’s minimum funding requirements. They are covered by PBGC insurance3 and must pay premiums. Sponsors’ financial reporting is based on DB plan accounting rules. Investments are pooled. The employer is on the hook to pay promised benefits if assets are insufficient.
Even though cash balance plans are designed around a notional account, which is typically paid or rolled over to an IRA at retirement (or termination of employment), they must, as an alternative, offer payment in the form of an actuarially equivalent lifetime annuity. In practice, however, almost no one takes an annuity.
…but the pilots’ plans are quite different from IBM’s plan
IBM’s plan is what I’ll call an “old-fashioned” cash balance plan.4 From an earlier post:
…IBM’s 401(k) contributions … have been replaced by a one-time 1% increase in pay plus a 5% “contribution” (really a notional pay credit) to a cash balance account in IBM’s existing DB plan.
…the notional account earns interest at 6% for three years, the 10-year Treasury rate with a 3% floor for 7 years (through 2033), and the 10-year Treasury rate with no floor thereafter.
The interest credits on the notional accounts are unrelated to trust earnings, and the total account balances can be quite different from the amount of plan assets (and reported liabilities).
The pilots’ plans (and similar plans) are often called “market based cash balance plans” (MBCBPs). These plans probably account for the majority of recently formed and still-forming DB plans. They are predominantly used by successful professionals (doctors, lawyers, dentists, etc.) and small business owners looking to minimize taxes. It turns out they also work well for highly paid union airline pilots looking to minimize taxes.
Notable characteristics include:
Unlike old-fashioned cash balance plans, contributions are (I understand) generally intended to be equal to the pay credits, and the plan investment portfolio aligns with the portfolio that defines interest credits. The idea is to keep the sum of the notional account balances very close to the value of the assets,5 like in DC plans. Operating in this manner would result in relatively low levels of risk for the plan sponsor.6
The interest credits of these pilots’ plans will be based on the returns of a portfolio that is invested 40/60 or 30/70 in stocks/bonds.7
A participant’s notional account balance cannot drop below the sum of her principal credits. This requirement for MBCBPs is called the “capital preservation” rule. It creates some risk for the employer. 8
Why go to the trouble of starting a MBCBP instead of just putting more in the current, or a new, DC plan?
Unlike IBM, the airlines are not eliminating contributions to their DC plan. The MBCBP is an add-on.
In fact, the airlines are increasing their 401(k) plan contribution rate, which is “non-elective,” i.e., it is the same even if the participant makes no elective contributions on her own. This rate is 17% of pay in 2025 and increases to 18% in 2026 for all four airlines.
Which brings us to the reason for setting up these new plans:
In their recent contracts, pilots negotiated significant pay increases.9 Pilots are well-paid, and many would like to minimize current taxes (defer taxation on current income).
As many people know, the amount of voluntary participant contributions to a 401(k) plan is limited to $23,500 in 2025.10
As fewer people know (because this rarely comes into play), the total of contributions, employer plus employee, to participants’ DC accounts is limited to $70,000 in 2025. This is referred to as the 415(c) limit.11
The pay that can be used as the basis for benefits provided in any conventional tax-advantaged (“qualified”) retirement plan, DB or DC, is limited to $350,000 (in 2025). For example, if an employer provides 5% non-elective contributions to a 401(k), the contribution for someone making $400,000 is $17,500 (5% of the lesser of $400,000 and $350,000). The $350,000 is called the 401(a)(17) limit.
The non-elective 17%-of-pay contribution for a pilot earning $350,000 is $59,500. If the pilot voluntarily contributes the maximum allowable $23,500 of her own money, the total contribution under the contract would be $83,000, which exceeds the $70,000 415(c) limit by $13,000, which could not go into the DC plan.
The MBCBP was added to allow for tax deferral of the $13,000 (in this example), called “spillover.”
Why didn’t they use another DC plan instead? Because the 415(c) limit applies to the total of all contributions to any DC plan.
However, the comparable limit for DB plans under Section 415 of the Internal Revenue Code - the 415(b) limit - is separate and additive, increasing potential total tax-deferred pay. 12 This is why the airlines added a DB plan. If all desired tax-deferred contributions could have been accommodated in DC plans, the new DB plans almost certainly would not exist.
While the MBCBPs must offer an annuity, the intent and expectation is that employees will take lump sums equal to their account balances. The Delta MBCBP 2023 (plan year) annual Form 5500 government filing13 includes the actuary’s plan summary and valuation assumptions. Of note:
100% of participants are assumed to elect a lump sum payment.
Under the plan rules, pilots can receive distributions (that can be rolled over to an IRA on a tax-deferred basis) while still working as early as age 59.5, but only if “capital preservation” does not apply. That is, the notional balance at the time of such an in-service distribution must exceed the sum of historical pay credits. The actuary assumes that 75% of pilots working at age 59.5 will take an immediate in-service distribution and that capital preservation will never apply.
Some miscellaneous notes:
Pilots at certain airlines may have other options for the spillover. At United, for example, there is a retiree healthcare account, which could be more attractive for tax and other reasons, depending on a pilot’s individual circumstances. In some cases, cash (taxable) is an option as well.
Spillover resulting from pay above the $350,000 (in 2025) 401(a)(17) limit will be paid in cash and subject to taxation (for all four airlines, I believe).
Some, maybe all, airlines are contributing an additional non-spillover amount to the MBCBP. This just represents additional pay that is tax-deferred, like a contribution to the 401(k).
To briefly get really technical (skip these following two bullets if you’re not a total pension nerd):
Despite benefiting only well-paid employees, these plans appear to be able to comply with the rules that prevent qualified plans from excessively favoring “highly compensated employees,” at least in part, because pilots are union employees and, therefore, subject to looser requirements.
Why not instead use a “non-qualified” Section 415 DC “excess plan” for the spillover? Probably because there is no way to avoid both immediate taxation and loss of benefits in the event of employer bankruptcy. Decreasing immediate taxation is the point here, and airlines have a propensity for going bankrupt.14 If such a plan were “funded” in a restricted trust not available to creditors, the amounts funded would be immediately taxable to the participant (I understand).15 (The assets in qualified DB plans, including MBCBPs, as well as DC plans, are never subject to creditors’ claims in bankruptcy.)
So, has the eagerly awaited DB Renaissance come to pass?
While providing DB plan benefits may be useful in certain specific circumstances - such as with IBM’s overfunded legacy DB plan or with airline pilots or successful professionals and small business owners looking to minimize taxable compensation - DB plans in corporate America are no closer to a comeback than Mike Tyson. I express no opinion here on whether that’s good or bad, but it bugs me when current events are misconstrued or their implications are exaggerated.
These pilots’ plans are about tax deferral for highly paid pilots. IBM’s replacement of 401(k) contributions with cash balance plan credits is about IBM effectively using the surplus in a legacy overfunded DB pension plan for its own financial benefit.
Neither case anticipates providing lifetime income to any significant degree. Neither qualifies as even a head fake in the direction of restoring the much-exaggerated golden age of traditional pensions.
As always, please let me know if you disagree with anything here or if you think I’m wrong about something.
The practice of union negotiations occurring around the same time among companies in the same industry, with the resulting contracts ending up very similar, is called “pattern bargaining.” Frequently, there is a target company where bargaining takes place first, and the resulting agreement is used as a template for the other companies. UAW negotiations with the “big three” U.S. automakers - GM, Ford, and Stellantis (originally Chrysler) - may be the original and most famous example.
PBGC stands for Pension Benefit Guaranty Corporation, the quasi-governmental entity modeled on the FDIC that pays participants’ benefits, up to certain limits, if an employer sponsoring a DB plan liquidates in bankruptcy.
It feels weird to refer to any cash balance plan as old-fashioned. It wasn’t that long ago that cash balance plans were new and controversial, like in 1999 when IBM originally went cash balance. I guess my age is showing.
As defined benefit plans under pension law and for accounting, it’s possible for things to get out of whack, where liabilities required for funding and accounting purposes are different from each other, and neither is equal to the sum of the balances. This is an unavoidable result of trying to force a DC peg in a DB hole. In old-fashioned cash balance plans, accounting liabilities are often less than the sum of the balances; in many (if not most) cases, that was a selling point. For example, an employer’s 5% of pay “contribution” would cost less than 5%! More actuarial/accounting magic, this time in the private sector!
Because DB rules apply, however, it would be theoretically possible for the sponsor to, for example, contribute in accordance with ERISA minimum requirements (different from the pay credits) and invest differently from the portfolio that defines the interest credits. Operating in this manner would obviously result in more risk to the sponsor.
While I encountered some complaints in my research that the asset allocations are too conservative, this is relatively easy for a participant to address by investing more aggressively in the 401(k) plan until her overall desired level of risk is attained.
Financially speaking, each participant owns a put on her account with a strike price equal to her total pay credits. The intent (or at least hope) is that this option will, over time, get so far out of the money - accounts will far exceed the sum of pay credits - that the option’s value will be almost zero. It’s safe to say that the actuarial valuations of these plans will not recognize any option value while it remains out-of-the-money, i.e., as long as participant pay credits are less than the account value for every participant. The probability of assets dropping below the sum of principal credits is greater than zero, however, so the option will always have some value, however small. If things go south, employers may have to contribute more than the annual pay credit.
For example, American Airlines “pilots will see an immediate pay raise of 21%, and combined with increases in 401(k) contributions and subsequent pay raises each May, pilot compensation rates rise by more than 46% during the contract’s duration,” which runs through 2027.
This number excludes so-called “catch-up” contributions permitted for older participants. All the dollar limits mentioned in this section are indexed and generally increase yearly. This limit is defined in section 402(g) of the Internal Revenue Code.
This is named after the relevant section in the Internal Revenue Code. Most retirement plan rules are in the 400s. Some favorites include 401(k), 403(b), 457, 415, and 401(a)(17).
Unlike the 415(c) limit that references a flat dollar amount, the 415(b) limit is defined in terms of a single life annuity payable at age 65, adjusted for other ages and forms of benefits (like lump sums).
I couldn’t find a Form 5500 for the other plans, probably because they were not in effect for a long enough period for this filing to have been required by the time of this writing.
According to a New York Times article from December 2024, “Southwest is the only one of the four largest U.S. airlines to have never filed for bankruptcy protection.” A Wall Street Journal article from January 2025 talks about the historical financial difficulties and failures in the industry.
This group probably doesn’t qualify as a “select group of management or highly compensated employees,” for which a top-hat plan might be another option. However, that would not be a perfect solution either for similar reasons around the tradeoff between tax deferral and security in the event of employer bankruptcy.