It has always amazed me that major airline pilots have such great paying jobs along with so many perks and there is so little information about how all of these perks actually work. I can't count how many times I have stood in front of a big group of pilots or flight attendants and have had their undivided attention when explaining how pensions, B-plans, and even 401ks are structured. It's not that they don't want to know, its just that there is very little information out there about how these benefits are designed. Even less, how to maximize each individual benefit in itself and as a collective whole.
Most airline professional love their jobs. All airline professionals would love to retire from their jobs with as many assets as possible. The key to maximizing that possibility is to have a good understanding about what benefits are offered and how to make them work together in concert towards your retirement goals.
One of the most misunderstood benefits that most major carriers offer their employees is an A-plan or most often referred to as a "Pension Plan" or “Defined Benefit Plan”. It is “Defined”, because the benefit has been pre-determined based on a certain formula.
As a very basic concept, pension plans are nothing but a promise to take care of an employee, in retirement, in return for many years of loyal service. Once retired, It is usually paid in the form of a monthly payment for the remainder of the employees life. Options are usually given to allow the spouse of the employee to take part in the benefit for the rest of his or her life, at the cost of a lesser monthly payment, but stretched out over two lives.
We will follow Capt. Maverick on a typical pre-retirement journey as he figures out what his A-Plan benefits are going to be so he can plan for his retirement. Capt. Maverick has worked for Hi Airline for 30 years and is 60 years of age. Capt. Maverick’s need for speed is long gone and he wants to retire. He calls the Benefits Department and they tell him his Pension Benefit is a monthly lifetime payment of $4000.00 per month if he takes that payment on his lifetime only. Pretty simple so far.
Lets assume that one day Capt. Maverick is on a long flight to Paris on the 787, and to pass time while waiting for his dinner, he gets out his calculator and tries to figure out how much the company will pay him over his lifetime. He looked the day before at actuarial tables from the IRS and found that the average longevity for a 65 year old male is 85 years of age. This means he is guaranteed to receive 20 years worth of $4000.00 monthly payments. With a quick authoritative whisk of the fingers, he calculates that those payments will equal $1,056,000 over 22 years. Not bad if he lives that long. Even better if he lives longer. Capt. Maverick’s mood brightens and with the prospect of dinner to arrive soon, the promise of a memorable trip has strengthened.
To continue, we will assume that Capt. Maverick actually lives until 85. The company’s obligation is to find a way to make his $4000.00 monthly payments no matter how long he lives. Half way across the Atlantic, Capt. Maverick just now realizes that the dollar figure for his Lump Sum Option was considerably less than the $1,056,000. In fact, it was only $636,039. How could that be?
The answer lies in the fact that, even though the company is obligated to pay him $4000.00 per month, they are not required to come up with the full $1,056,000 up front.
The reason for this is that the IRS allows companies with pension plans to “invest’ money to guarantee the required monthly payment. The investment vehicle is a combination of interest rates, applicable to all pensions, commonly referred to as the Composite Corporate Bond Rate (CCBR). For simplicity purposes, lets assume that this rate equals 5%.
In order to provide Capt. Maverick with his $1,056,000 over the next 20 years, the company only has to come up with $636,039, if it can invest it at 5% interest. If the current interest rate being used was higher, then the company would have to come up with even less. The reverse is also true. If the interest rate being used was lower, then the company would have to come up with a larger amount of money for Capt. Maverick.
In summary, defined benefit pension plans are designed to provide you with a lifetime annuity. They use mortality (life expectancy) tables to predict the expected cost of your benefit.
By electing the lump sum option, you remove the ability of the plan to invest the assets in an annuity. It is assumed that the Pilot could invest the lump sum and earn the interest rate in effect, when the lump sum was paid. Theoretically, this will produce the same annuity benefit the plan was willing to pay, based on the applicable interest rate.
Capt. Maverick has a very important decision to make regarding his retirement and it is certainly one that should not be take lightly. The choices are seemingly endless and I always highly recommend hiring a professional to at least be presented with all of the investment options, should anyone decide to take a lump sum.
Pension plans are great benefits and usually the greater part of someone’s nest egg. Aside from all of the technical theory behind such benefits, it is crucial to always keep in mind that your situation is unique and should be treated that way. A properly designed financial plan is always the answer and it has to include all of your other assets so that you can get an inclusive collective picture of your individual situation.
If you are interested in learning more, in detail, as to how your benefits are structured and to enhance the possibility of getting the most out of what is offered to you, please feel free to call us.
Alex A. Tapia, AIF ® President and Retirement Wealth Planner Aviation Retirement Strategies, LLC.