OPT IN OR OUT? AMERICAN AIRLINES MARKET-BASED CASH BALANCE PLAN EXPLAINED

Tim:[00:01:23]Well, welcome to this episode of Pilot’s Portfolio. If you’re new here thanks for
joining us, My name is Timothy P Pope. I’m your host, I am a certified financial planner and
principal at 360 aviation advisors, where we focus on financial planning for the professional
pilot. I’m also a GA pilot flying the 172 and an SR20. So, love to get some time in the air
when I actually have the time to do it. So, with that let’s jump into today’s episode. So the
first question, what is. The market based cash balance plan on its face, right, it’s an
additional retirement plan to help you defer taxes that you would’ve otherwise paid today
when you received the company’s NEC or non-elective contribution. So a few episodes ago I
told you about the IRS contribution limits for 2026. So if you missed that episode, go back
and listen to it and I kind of outline everything for you there. But you’ll recall that the 2026
401k contribution limit for you to put in, if you’re in the age of 50, is 24,500. And you can do
that, either pre-tax or you can do Roth.

[00:02:38]And for a moment, we’re gonna ignore the, mega back door, strategies here.
Alright, so you can put that, 24,500 in and then your money and the company’s money
together, cannot exceed $72,000. Alright? there are, again, there are some nuances. So if
you are 50 or older, or between 61 and 63, you can put in a bit more money. Then what I just
mentioned, it’s not gonna count against that $72,000 limit. So here’s where the
market-based cash balance plan comes in, because as you guys know, with your most
recent contract, you have this incredible company contribution, not even a match. You show
up, you fly the airplane in 2026, the company is going to put away 18% of your
compensation inside of your 401k.

[00:03:23]The problem is, with 18% on the salaries that you guys command, we quickly run
out of tax deferred places, for that non-elective contribution to go. So all the major airlines,
went to the IRS. And they ask for permission, to begin using what’s called a market-based
cash balance plan. These plans are very popular in other industries where folks are highly
compensated and run into the same problems that you do. Hey, we have all this money
we’re running out of places, for tax deferred growth. Recently, the IRS has given Americans
the blessing to use this plan. And so now you guys have to make this choice between now
and December 15th on if you’re going to participate. Essentially the way it works is your 401k
starts to fill up and when you either hit the 72,000 between yourself and the company’s
contributions, then the rest of it is either going to the market-based cash balance plan if you
choose that, or it’s going to come to you in cash. The other way is that, if you are making
more than $360,000 a year, then the non-elective contribution is going to stop going into
your 401k. And if you choose the market-based cash balance plan, it’s gonna start filling up
there instead.

[00:04:36]So let’s go over some numbers. When would the market-based cash balance plan
be applicable to you? Alright, so number one, if you are maxing out your 401k in 2026. You
can expect to receive spill cash when your earnings exceed $264,000 from the company. All
right, so then that spill cash, that’s what we’re talking about here.Does that just continue to,
be sent to you in your check as it’s done today, or do you opt into the market-based cash
balance plan and it’s deferred and you don’t pay taxes on it as it flows into your
market-based cash balance plan? At least you don’t pay taxes on it today. The other
scenario, gonna do the bookends here, is if you’re putting $0 in your 401k, you can expect
spill cash when your earnings exceed $360,000.

[00:05:25]Okay? That 360,000 is the number, the IRS says, Hey, the company can only
consider putting the NEC into your 401k on your first $360,000 of earnings above 360,000.
The NEC has to go somewhere else again to you and a paycheck where you pay taxes on it
or to the market-based cash balance plan where you defer taxes. So,in the first example, we
had 264,000. The second example we’re at 360. That’s almost a hundred thousand dollars
difference, okay? Of when you can expect spill cash or not given if you’re maxing out the
401k or not. So if you are contributing something in between. Zero and the max of 24,500,
then you can expect spill cash somewhere in the middle. All right, so we’ve gone over the
numbers there. Let’s talk about how American Airlines plan differs from the rest of the
industry. And here’s where it differs from the rest of the industry so far. It differs because you
guys have choice. Alright? You can choose, in three year segments whether you’re gonna
participate in this.

[00:06:28]So let’s say that you choose, December 15 to participate, then you’re going to
participate in the market BA cash balance plan, in 26, 27, and 28. Alright? And then at the
end of 28, you’re gonna have another choice. Hey, do I want to continue, participating in this
or do I not want to continue participating in this? So every three years, you’ve got an option
to either opt in or opt out. And from a financial planning perspective, that is an extraordinarily
valuable planning tool. That is a really big deal because you guys will remember a couple
years ago when Delta came out with theirs, their pilots had to make an irrevocable choice, all
right? Whether they opted in or opted out, you know, hopefully maybe they can revisit that,
and give their pilots choice like this. United pilots, the plan they came up with was an annual
choice. Now they have not passed their market-based cash balance plan yet. They’ve not
implemented it yet. It looks like it’s run into some issues there, but we see that, Hey, you
know what the, IRS.Kind of likes at least a three year window. So that seems to be cool. And
then with Southwest, they just said, Hey, you guys are gonna get this right. So you’re gonna
get 1% into it. and then you’re gonna get 2% into it starting in 2026. So that’s how it changes
or it differs from the industry and, you know, let’s talk about that flexibility there for a moment.

[00:07:47]As a planner, I can see just a number of scenarios where that flexibility could come
in handy for you. Let’s say that you’re on a stage right now where you’re saying, look, I need
to build some non-qualified assets. When we say non-qualified, we mean brokerage. We
mean I can spend it today money, we mean, I call it no strings attached money with the
clients, right? So, we need to build some non-qualified assets because we’ve got some plans
that we need to take care of before age 60. Which is the earliest that you could roll money
out of this market-based cash filing plan. Or 59 and a half if we’re counting half years. So
you’ve got some plans that you need money now. Maybe you’re in a scenario where you
inherited some retirement accounts from your parents and next thing you know, you need to
distribute $1 million or more. And because of the changes in the rules on those plans, you’ve
got 10 years to do it. But you know, you’re doing pretty well at your current job, um, at the
airlines, and your spouse is doing well also.

[00:08:39]So, you know, maybe in that scenario you. Opt in to defer that spill cash while you
unwind some of these pre-tax accounts. Okay? maybe, you know, you’re about to sell
several rentals and you’re not gonna 10 31 it you know you need the cash. And so maybe
you’re gonna be facing capital gains, depreciation, recapture, and so forth. And so maybe
you decide to defer the spill cash for a few years. So the ability to choose every three years.
I think is an extraordinarily valuable planning tool and as it relates to market-based cash
balance plans in and of themselves. I think that one, you know, this feature here pushes the
American plan to be my favorite, of what we have out in the industry right now. So let’s take
a look at how it differs from your 401k. Unlike your 401k, you are not going to be able to
directly influence how much money you put into this plan. Okay. This is all formula driven. It’s
all based off of, how much NEC you earn and if that NEC, exceeds some of the limits that
we talked about previously. So, you’re not gonna have direct control over how much spill
cash goes into the market based cash plans plan. There are levers that you could pull, like
you could reduce your own 24,000, 500. You could reduce that down to some number less
than that, all the way down to zero and allow more money to go into your 401k or market
based cash balance plan.

[00:10:03]So, there’s some ways to indirectly control it, but unlike your 401k. You can’t go
and say, hey, I want 10% or 5%, or whatever going into this, uh, market-based cash balance
plan. Number two, it’s different because in your 401k you have complete control over the
investments, okay? So you can build the portfolio that suits your needs. And since you are
the one building the portfolios, you also are bearing the investment risk and responsibility in
the market-based cash balance plan. You do not get to control the investments., Typically
these plans are going to be invested in a more conservative manner, because they do
guarantee that when you take your money out, you will have no less than what you put in.
Now, as we talk about the investment side, A PA and the company has done an excellent job
creating this plan, especially giving you guys the flexibility to choose every three years. I love
that, and I think that’s what we call a real valuable financial planning tool, but what frustrates
me and, what should frustrate you, and you should raise your collective 16,000 voices and
say, we want more transparency on how these investments are going to be managed. In the
23 pages of documents that I’ve reviewed about this plan, when it comes to investment
management, all you guys get is a sentence that says, market-based cash balance plan
assets will be professionally managed by an investment manager selected by the market
based cash balance pension plans fiduciary.

[00:11:29]That’s cool, but we want more than that. Okay. At least in the Deltas plans, you
know, they said the fund manager’s gonna target, you know, 40% stock and 60% bond
allocation. So then as planners, we can go and look up historically how that mix of stocks
and bonds have performed over the long term. And then we can apply that rate of return to
any money you have in your plan. And then also knowing, and in that mix of how the plan is
gonna be invested. We can go and reallocate other parts of your portfolio. So A PA
American, market-based cash balance, pension plan, fiduciary. We need a little bit more
from you.You guys. Please tell these pilots. The target asset allocation on this, tell the pilots
that you reserve the right to deviate from that target asset allocation from time to time, and
then tell the pilots the guardrails that if you, if and when you deviate, here are the guardrails
you’re gonna stay within.

[00:12:24]I’m fairly certain that that’s just par for the course. Whenever managing money.
Ask me how I know. All right. So, you’re not gonna be able to have complete control over the
investments. But on that point, we do need and we want more information on how they plan
to invest this. Number three, there are going to be no Roth conversions inside the
market-based cash balance plan. Alright, so inside that plan itself. Once the money’s in
there, it is going in there tax deferred. It’s gonna stay tax deferred until you roll that into an
IRA later, and then once it’s in the IRA, you can do whatever you want with it. are some
similarities, to your 401k. It does enjoy unlimited creditor protection. Just like your 401k is not
subject to the company’s creditors, especially in the case of a bankruptcy situation. The
market based cash balance plan also enjoys that protection. And just like you know, your
401k, in many cases is not subject to your own. Let’s say you get into a sticky situation, you
have some liability. Your 401k is not subject to those creditors either, and the market based
cash balance plan would not be as well. Also, let’s talk about beneficiaries. If you die, before
you get a chance to use this money, it will be passed to your beneficiaries as you elect. And
so both of those elements are the same as your 401k.

[00:14:44] Now, let’s get to the question that everybody wants to know. Is this plan good for
me? Should I opt in and should I, or should I opt out? I’ll tell you, I have listened to other
advisors on this topic actually. When Delta’s was coming out, I’ve listened to others, and they
take a really negative view on the market based cash balance plan. Okay. And I think when
you look at it and you say, look, this, the only thing that this thing offers is a conservative
investment with a tax deferral feature, it’s bad. I think that’s a rather simplistic view, of the
plan. It really doesn’t consider the flexibility to someone’s broader financial life that this can
offer and the nuance that all of you guys have, in your lives.

[00:15:49]Okay? If you’re maxing out your 401k and you’ve been doing that for a long time
and the company is also, giving you a whole lot of NEC chances are, the goals that you are
focused on are not simply retirement goals, right? Like retirement’s going to be fine, but then
there’s other goals that take its place. We think about legacy, we think about just flexibility to
do other things. I say, okay, so when you think about the market-based cash balance plan,
you want to think about it as a flexible tool. So, you know, maybe you’re late to the savings
game. Maybe you need to save as much as possible so you can be successful. In
retirement, but you know yourself and you know that if the funds end up inside your bank
account, you’re probably gonna spend them. Market based cash balance plan is probably
useful for you. One of the features in the market based cash balance plan is that it cannot,
you can’t do Roth conversions, but I do think the market-based cash balance plan can
actually enhance your Roth positions without having to pay more tax than you would, like if
you had taken this cash. I wanna give you an example on that. Okay? And I’m not gonna
dive deep on this. I’m not gonna say everybody should use it, but I’m just gonna let you know
like, hey, here’s a strategy that’s out there that you could use.

[00:16:35]So let’s say for example, you max out your 401k and you do Roth at 24,500. And
then you also do backdoor Roth for you and your spouse. Let’s say you’re married filing
jointly at 7,500 each year. Okay? So. That’s 39,500. Where else can you go to get more
tax-free raw shelf space? And if you say, well, you could do mega back door Roth
conversions, you would be right. With the market based cash balance plan, if you had
elected that, you would still receive spill cash as cash and it, that portion would not go to the
market based cash balance plan. So we’re gonna ignore those mega backdoor Roth
conversions for a moment. After you max out your 24,500, you do your 15,000 in Backdoor
Roth. Okay? That’s 39,500 in tax-free raw shelf space. We love that. Where else can you go
to get more, Roth tax-free raw shelf space. The only place you can go is you can do Roth
conversions, right? And those are gonna be taxable to you in the year in which you convert
them. So either you take the NEC as cash, all right? So you pay taxes on that, you toss that
money in a brokerage account, and then you do Roth conversions. You’re gonna have to pay
more tax on the Roth conversion. So now you’ve paid tax on the spill cash, and you’ve paid
tax on the Roth conversions. Okay? Or if you elect the market based cash balance plan, you
can calculate every year, Hey, how much money would I have paid on the spill cash that
went into the market based cash balance plan? Then you convert a similar portion from the
401k or if you’ve got old IRAs, And that way you’ve expanded your shelf space, your tax
free, shelf space without having to pay tax on both the NEC that you receive as cash and the
Roth conversion. Look, why would somebody wanna do that? Well, brokerage account, I am
going to pay taxes on it now, and then I’m gonna pay tax on my long-term capital gains.
Either 15% or 20%. Hey, that is better than 35 or 37%, for sure, but it’s still 15 or 20% in the
Roth. I pay taxes on it once, and then I never pay taxes on the gains.

[00:18:36]So, for one thing we can think about, legacy planning, Hey, I’ve got everything that
I need. I’m really thinking about the next generation here. I’d like to leave them the biggest
bucket of Roth dollars as I can. ’cause they’re not gonna have to pay taxes on it. Yes, in a
brokerage they’ll get a step up basis,but still that’s not tax free. depends on how they use it,
but the Roth is so, you know, is this a strategy for everybody? No, is it a strategy to use all
the time? No, could it be useful? Yes. Okay, and I say that to just demonstrate the flexibility
that this plan could use. Maybe you are, you know, running a company and your return on
capital far exceeds what your money does in the market. Okay. Especially when you factor in
the tax breaks and so on. All right, well, in that case, maybe you’re not interested in using the
market base cash balance plan. So, think about this as a tool, as it’s, you know, when we
use the right tool for the right job. It’s awesome. If we use the wrong tool for the job, then it’s
terrible.

[00:19:38]Okay? If you ask me, Tim, how do you feel about screwdrivers? I’m like, well, if I’m
doing a pre-flight on the Cessna and I see that the rivet on the cow Lang has popped out
once again, as it’s known to do, I love myself a screwdriver and pop that thing back in before
take off, But if I’m looking at the wooden picnic table in the backyard that the kids have
broken. And I wanna pound some nails in it to get it fixed. And I’m not interested in a
screwdriver. And please don’t ask me how you break a picnic table. I have no idea. I asked
my wife the same thing. How in the world did they break this? So I think bottom line with the
market-based cash balance plan, it’s not inherently good or bad. I do like the flexibility on it. I
do think you guys should consider your own financial circumstance and then make a
decision from there. And the good news about it is, look, you get to choose in another three
years anyway. So if someone is saying, Hey, this plan is terrible, I think that’s a fairly
simplistic view of it, and it certainly doesn’t consider all the nuances that you guys have in
your financial lives. So with that, be sure make your decision by December 15th of this year.
Thanks for joining this episode of Pilot’s Portfolio, and we’ll see you on the next show.