SHOULD SOUTHWEST PILOTS TAKE THEIR NEC AS ROTH?

Tim:[00:00:01]If you accept your NEC as Roth or elect to take it as Roth, rather, the company will not withhold any federal income taxes or FICA taxes for you. I’m gonna repeat that ’cause I think that’s important. The company will not. Withhold any federal income taxes or FICA taxes for you. So this is a big deal, right? You get your federal income tax, your state income tax if you live in a state that has income taxes and then your FICA taxes. The point here is, depending on how much any C you elect to take as Roth, you could end up under withholding throughout the year. So if you choose this option, you may need to think about paying estimated taxes throughout the year, or in certainly sending something aside so you can pay that tax bill. When do, I don’t think that’s gonna be an issue for many of you, but I do think it’s something you want to be aware of so you’re not caught off guard.
[00:00:57]You are listening to the pilot’s portfolio, the show dedicated to guiding professional pilots. Towards the future of financial success and stability, fly along with your host Timothy P. Pope, as he provides financial planning insights and answers to your burning questions and dives into real life stories from fellow pilots who share their successes and cautionary tales.The pilot’s portfolio takes off now.
[00:01:26]Welcome to this episode of Pilot’s Portfolio. This is the show where we discuss all things financial planning for professional pilots. My name is Timothy P. Pope. I’m a certified financial planner and principal at 360 Aviation Advisors, where we specialize in the planning needs of the professional pilot. So that means retirement tax investments. Our specialization. That means we know the aviation industry, we understand the financial lifecycle of professional pilots, and we understand the opportunities and challenges that are set before you. And so if you are new to the show, welcome. If you’ve been listening for a while, welcome back and do me a favor.
[00:02:10]Take a moment, write the show wherever you listen to the podcast, and let that reflect the value that you’ve received from the show. I’d appreciate that. So in this episode we are going to talk about a new option that Southwest pilots have. So starting this year, 2026, if you fly for Southwest, you can elect to take your NEC as Roth, so if we take a trip back down memory lane back in 2022, when the Secure Act 2.0 passed, one of the features that that legislation said was, hey, beginning in 2026, employers would have the option to offer matching employer contributions or any C contributions as Roth. They are not obligated to do so, and Southwest is certainly leading the way on this amongst the majors, and they’re allowing the NC to be taken.
[00:03:00]As Roth for their pilot. So as a reminder, the NEC, that non-elective contribution, that’s the amount that the company just puts in your 401k for you, right? You show up, you fly the airplane, and Southwest puts in 18% of your compensation into your 401k. This does not include the 2% that Southwest Pilots automatically received in their market-based cash balance plan, regardless of if they have a spill cash or not. So what does it mean when we say Roth? So when I say Roth, I’m talking about a tax structure. I’m talking about dollars that you agree to pay income taxes on today. And in return, you will not have to pay any taxes on your earnings when you take the money out of the account in the future. So there’s a couple stipulations, right?
[00:03:49]The account has to be open for at least five years, and of course, you need to be at the retirement age when you withdraw the money. So if you meet those two requirements, then your earnings will not be taxed. Now, previously when you received your NEC, it came to you automatically as pre-tax, right? So this is money that you did not pay taxes on the principle and the growth whenever you took it out in retirement, you would have to pay taxes
on it at that point. And if you wanted it to go to be Roth, then you’d have to do what’s called an in plan Roth conversion. You’d have to manually go and convert those dollars. Now I think the ability to take the NEC as Roth, it’s a move that levels the playing field here. I mean, a few years ago when all the airlines were rolling out their market-based cash balance plans, one of the big concerns and major criticisms of naysayers were saying, hey, pilots already have a lot of pre-tax money via the NEC.
[00:04:45]And pilots who are strong savers, I call ’em Super Savers, will have tremendous tax bills in retirement. And you know what? Both of those are true. Especially the second one, if you don’t plan for it, and if you don’t take the appropriate action. And I would spend time talking with clients that there are some indirect levers that you can pull to still use the market-based cash balance plan and influence your current and future tax liabilities. Now, for Southwest is giving its pilots a direct lever. To pull and that is to accept your NEC as Roth. So here’s what it means if you decide to take your NEC as Roth. So of course we’re gonna pay taxes on it this year. Previously, when the company gave you your NEC, it did not show up on your W2. If you take your NECS Roth, it will show up on your W2 as taxable income.
[00:05:37]The other note is if you accept your NECS Roth or elect to take it as Roth, rather, the company will not withhold any federal income taxes or FICA taxes for you. I’m gonna repeat that ’cause I think that’s important. The company will not withhold any federal income taxes or FICA taxes for you, so this is a big deal. Right. You’ve got your federal income tax, your state income tax, if you live in a state that has income taxes, and then your FICA taxes, so your FICA taxes, those are the payroll taxes, right? That’s your social security, which is the 6.2%, and then the Medicare portion of fica, which is the 1.45. I would probably argue that the fact that they’re not gonna withhold. The social security part of the FICA is probably less of a big deal, and here’s why. If your Social Security wage base meets or exceeds 184,500 this year, then you’re gonna max out a social security anyway. And you know, you’re gonna do that on the other part of your pay, right? I mean, if you’re trying, you can hit that in year two and definitely by year three if you’re taking it easy, right?
[00:06:42]That 18045 on your social security wage base. So that’s gonna max out the Medicare portion though. That 1.45% tax does not have a cap, and that’s gonna continue all the way up in the top range of your income. And then there’s an additional Medicare tax that starts at 200,000 or 250,000 of modified adjusted gross income depending on how you file, right? So 200 for single and 250 for me filing jointly. So, the point here is depending on how much NEC you you elect to take as Roth, you could end up under withholding throughout the year. So if you choose this option, you may need to think about paying estimated taxes throughout the year or in certainly setting something aside so you can pay that tax bill when due. I don’t think that’s gonna be an issue for many of you, but I do think it’s something you want to be aware of so you’re not caught off guard. So I’m gonna give you an example. Let’s say that you’re in the 32% marginal federal bracket. Okay, and then let’s tack on that Medicare tax of 1.45, and let’s tack on the additional Medicare tax at 0.9%.
[00:04:48]Okay? We’re also gonna assume that you’ve maxed out your swap at NEC. So you’ve made $360,000 or more here. And indeed, if you’re gonna be in the 32% tax bracket or married, finally jointly your, your taxable income will need to be above that amount. And so we’ve got your federal, we’ve got your fica, and then we’ve got your additional Medicare tax. And let’s say that you’ve taken all of your Southwest NEC as Roth this year, that’s gonna result in about $22,259, right? Of additional taxes that you are going to expect to pay. Now, this is just an example. Of course, there could be other things that you have available to you to offset some of your ordinary income taxes. There could be other taxes that applied like the net investment income tax as well that I did not capture here. So this is just for illustration purposes only. So. You’re in that 32% bracket, you max out your swap at NEC. You take the
whole thing as Roth big picture, we’re gonna have a little bit above 22,000 in federal income tax.
[00:08:48]And then if you have a state that has a state income tax, you’re gonna have to add that as well. So what if you are saving for something like a home down payment or some other near term goal where you could use that cash? Well, maybe this year you keep your NECS pre-tax. You take the money that you saved by not paying the additional taxes here this year. You take that and you apply it to whatever goal you have, and then once that goal is met, you can reconsider if this tool makes sense for you. You know the thing is you get to choose. You get to choose if you elect your NEC as Roth, and then you also get to choose how much of the NEC you take as Roth, right? You can change your elections throughout the year. If you wanna do the first quarter of the year or the first half of the year as Roth, and then flip it back to pretax. You certainly can. You know, I think like any good tool, the flexibility of this feature is worth its weight and gold. You are the PIC on this thing.
[00:09:47]You get to determine when you use it, how much you use it, and you can get really detailed in your tax planning and investment planning here. In fact. You know, for our Southwest clients, maybe we’ll add a bullet point to their Q4 quarterly planning meeting to say, hey, next year how much of our NEC are we gonna take as Roth? Or are we gonna take our NEC as Roth? And how much of it, right? A great thing to know is you come into the new year, you can set it up and monitor it that way.
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[00:11:22]Let’s talk about a use case, right? So who could use their NECS Roth? And certainly for early career pilots, this could be a tremendous benefit. Having time on your side and you’re typically in a lower tax bracket right as you get going. So usually for our clients, we say, hey, if you’re marginal, federal, and your state, when combined, if they do not exceed 30%. Then we’re probably very interested in Roth dollars coming in. Once they combine and exceed 30%, then we’re gonna take a closer look at it. Now, if you are an early career pilot, you have decades and decades to go, but you’re just crushing it right? Then we may say, hey, it exceeds 30%, but you have time on your side, and because you have so much of your career ahead of you, we believe that tax rates will be higher in the future on individual income.
[00:12:13]We’re gonna have to make a strategic decision here. The tool itself is flexible, and I think your use should also be flexible just because it exists. I don’t know that I just blanket and run and say Everybody everywhere should be 100% Roth NEC from now until they retire. I don’t think that that’s good planning. The other thing is not all is lost. Like if you’re thinking about this and saying, hey, I don’t think that doing a Roth NEC is right for you at this time, that’s okay because I talk to clients about the fact that markets are cyclical and we haven’t had a really down and nasty just drug out turn in the market since 2007, 2008, 2009 kind of time, right? Those time periods, they come and they go, and thankfully we haven’t
had to look at a nasty one in a long time, but they’ll be back. And when they are, that could be an opportunity for you to then go and make some Roth conversions, right? Because all of the accounts will be lower at that point.
[00:13:15]So there are some other tools in your toolbox that you have, even if taking Roth NEC isn’t something that you’re interested in or able to do ’cause it doesn’t make sense for you right now. Now I wanna say this, if you don’t fly for Southwest and you made it this far in the episode, well thanks for sticking around, right? You have a thirst for knowledge, but all is not lost. I’ve got something for you guys as well. So I was recently on the 21-5 show discussing this very topic, and afterwards I received an email from Brian who works at United and he said, hey Tim, well we have a similar option at United. We can convert our NEC to Roth. And he wanted to make sure he wasn’t missing anything. And that was a great question. ‘Cause Brian, you’re not missing anything. United American Delta, all of you guys have the option to convert your NEC to Roth. I think it’s important though, to address the Southwest pilots because number one, they have this new tool, they have this new option, the receiving communication around it. And then number two, because of the inherent tax gotchas. So previously when you received your NEC, you didn’t have to worry about any additional tax withholdings, right? You just received it. Folks need to just be prepared to know that, hey, if you switch over to Roth, you do need to be concerned about and plan, not concerned, but you need to plan around your additional tax withholdings.
[00:14:30]And then for those who are doing Roth conversions, you’re at the Southwest or United and Schwab is your interface, or if you’re at Delta or American, and Fidelity’s your interface as you go through those in plain conversions. The screen is gonna pop up and it’s gonna let you know that, hey, this may be a taxable event, right? Do me a favor, please don’t withhold taxes while you’re doing the conversion. Right? You know, you wanna pay those from a separate place. So thanks for that question, Brian. Guys, I wanna say I certainly appreciate you tuning in to the show. Big shout out to our sponsors at Beacon Relocation for supporting the show. And shout out to our listeners, appreciate your support, appreciate your questions. There’s a couple questions that have come in that I’ve gotta get to. So those will be coming out in future episodes. And for the pilot out there who’s listening and who has noticed that you’ve found financial success, but all of a sudden it seems that you don’t have enough time in your day to do everything on your plate.
[00:15:22]You still have lingering questions about your financial future? Well, if you are ready to take the relationship to the next level, to partner with advisors who know your industry and specialize in serving professional pilots, both airlines and business aviations, schedule an appointment. Let’s talk. That’s gonna do it for today’s episode. Thanks for tuning in, and we’ll see you on the next one. Thank you for joining this episode of Pilot’s Portfolio. If you found this information helpful, spread the word and share it with a pilot button, or if you have questions. And there’s something that you would like to hear discussed on the show, send us an email. You can find the address in the show notes. For those of you who are ready to learn how we help professional pilots with their financial planning needs, schedule an appointment. Until next time, keep the shiny side up and we’ll see you on the next episode.
Pilot’s Portfolio is hosted by Timothy P. Pope. Timothy P. Pope is principal owner of 360 Aviation Advisors. 360 Aviation Advisors is a registered investment advisory firm regulated by the state of North Carolina in accordance and compliance to the securities laws and regulations. 360 Aviation Advisors does not render or offered to render personalized investment or tax advice through pilot’s portfolio.
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