Which is better: a pension or a well-funded 401k account?
One of the reasons I started writing about Pilot Math is that I’m sick.
I’m sick of people making bad decisions and then saying it’s my job to fix their problems. I don’t mind people considering emotions in big decisions, but I’m sick of people making emotionally-driven decisions without giving sufficient weight to actual data. I’m writing about pensions today because I’m sick of hearing about lost pensions and how great they are (or were).
Yes, in the early 2000s a combination of bad laws, a market downturn, and some highly questionable corporate decisions led most airlines to abandon pilot pension plans they’d committed to funding in perpetuity. The airline’s part in this whole drama was irredeemably deplorable, and the pilots of that era deserved better.
However, those pension plans are gone and they aren’t coming back. The appearance of new Market Based Cash Balance Plans (MBCBPs) in the most recent wave of major airline contracts all but seals that deal.
Why even discuss pensions then? Recent events set up a case study that conveniently provides us with some real-world numbers for a head-to-head comparison. Yes, you’re getting another PMTB spreadsheet to play around with.
My Writing Prompt
The events in question started with the recently failed Tentative Agreement (TA1) at FedEx. This proposal attempted to address some shortcomings of their pension plan, gave current pilots the option of shifting to a different system, and would have excluded future pilots from the legacy pension plan altogether. I have no doubt their next TA will include similar provisions of some kind, meaning a few thousand of those pilots will likely have the option of sticking with or freeing themselves from their pension plan going forward. This will likely influence negotiations at UPS as their contract extension runs out in 2025.
I got some negative (and lots of positive) feedback when I weighed in on FDX TA1. I might not have written this at all until the FedEx ALPA MEC posted two new episodes to their podcast, Fly By Night. (Here’s Part 1, and Here’s Part 2.) A fantastic production, this podcast does a great job listing the strengths and weaknesses of DB pension plans, newer Defined Contribution (DC) plans like the 401k, and potential options like MBCBPs.
This article focuses on an academic discussion in hopes of helping end an industry-wide debate that should have died out long ago. I have friends at both brown and purple, and include some considerations in hopes of ensuring those union brothers and sisters have context for their upcoming negotiations. I do that somewhat selfishly hoping that any retirement reforms they gain might influence the MBCBP at my own airline during our next round of negotiations (as has already happened with United). If my writing about purple topics induces pain in your posterior, then you need to read this disclaimer, then move on to a different website.
Pension Valuation, Part 1
One of the big weaknesses of the current FedEX DB falls under what the podcast episode called a “contractual cap.” Although top pay rates at $335/hr mean senior FedEx captains likely earn well in excess of $335,000 per year, their pension calculations are all based on a maximum Final Average Earnings (FAE) of $260,000 per year. Maximum pension benefits (at 25 years of service) are 50% FAE, meaning the most a FedEx pilot can possibly get in retirement is $130,000 per year.
That’s a lot of beer money for not showing up at work anymore, but how much value does that actually represent?
Trinity University and the 4% Rule
In the late 1990s, some smart geeks at Trinity University investigated an interesting question: if a person retires at age 60 with a nest egg saved up, and lives for 30 more years, how much of their retirement savings can that person spend each year without running out of money before they die?
Commonly referred to as The Trinity Study in personal finance circles, this rigorous mathematical examination considered every 30-year period in the entire history of the stock market, running separate scenarios that both accounted for and ignored inflation. They considered a variety of withdrawal rates expressed as percentages of the original balance of the retirement account, to find out which ones would last for at least 30 years.
If you haven’t read this study yet, you should. The results changed my world forever, and my family enjoys a life of financial independence, free of monetary worries, as a result.
The Trinity Study concluded that in almost every 30-year period in the history of the stock market, a retiree could safely spend 4% of their portfolio’s initial value each year and not run out of money. This includes the worst case scenario we have…retiring the night before the Great Depression started. How’s that for peace of mind?
The Study also noted that 4% is extremely conservative in many cases. In many 30-year periods, much higher withdrawal rates still lasted the retiree until age 90.
As further evidence that the 4% rule is very conservative, the study also looked at how much money would be left in a given retiree’s account after 30 years. In the overwhelming majority of cases, spending levels at or well above 4% resulted in significant funds left over. In many cases using the 4% rule, the ending balance in the account was more than double where it started! I believe most pilots are safe to spend well above 4%, though you should definitely consult with a Certified Financial Planner before doing so.
If you want more reason to believe the 4% Rule is way too conservative, I strongly recommend listening to Episode 351 of the BiggerPockets Money podcast with Michael Kitces. He spells everything out very effectively.
The financial independence community has latched on to the safe/conservative results from this study and refers to them as “The 4% Rule.” A pilot like you or me can use this rule to calculate how much money we need to save to achieve a desired retirement spending level (divide your desired annual spending by 4%, or 0.04), or it can tell you how much you’re allowed to spend each year based on the size of your nest egg (in this case, multiply the nest egg’s value by 0.04).
Although I think this is a great rule of thumb, there’s a strong case for saying it’s unnecessarily conservative. In many of the Trinity Study’s scenarios, spending rates upwards of 8-9% still succeeded much of the time.
It’s also unnecessarily simplistic to assume a retiree will spend the exact same amount of money each year, every year, no matter what. It’d be valid for a retiree to plan on adjusting annual spending in the 4-9% range, based on market performance, with the help of a CFP.
I’ve also demonstrated that the average American family can live a happy, comfortable life on far less than 4% of the nest egg that an average US airline pilot will accrue during their career. Unless you spend money like a fool, your airline pilot career should give you great peace in regards to personal finance.
Knowing this, let’s go back to our pension discussion.
Pension Valuation, Part 2 – Applying the 4% Rule
Having reviewed the 4% rule, let’s consider how much the FedEx pension is actually worth. The current FAE cap is $260,000, resulting in an annual payout of $130,000. Applying the 4% rule equates this to having a nest egg of $3,250,000 on the day a pilot retires.
We’ll also consider two other scenarios here. The failed TA1 offered current pilots the chance to switch to a MBCBP going forward. This would have frozen their current pension benefits and assigned a new, higher FAE cap of $290,000. TA1 also raised the cap for pilots sticking with the old DB plan to $338,000. These higher caps would have represented annual pension payouts of $145,000 and $169,000, respectively. Applying the 4% rule equates those payouts to nest eggs of $3,625,000 and $4,225,000 at retirement. Let’s present those in a table:
| FAE Cap | Annual Payout | 4% Rule Equivalent | |
| Current Contract | $260,000 | $130,000 | $3,250,000 |
| TA1 MBCBP Opt-In | $290,000 | $145,000 | $3,625,000 |
| TA1 Cap Increase | $338,000 | $169,000 | $4,225,000 |
At first glance, this seems like a lot of money. If you can’t live an amazing life on $130,000 in modern society, you’re doing something wrong…especially after a career where your earnings should have been more than enough to pay off your house, fund important family activities and events, and buy plenty of toys.
Yes, I am judging you…just like I know you’re judging me.
Increasing that benefit to $145K/yr or even $169K/yr just adds more icing on top of an already thoroughly-frosted cake.
In the 2000s, most airlines used bankruptcy to abandon their pension plans and started instead making direct contributions to individual pilot 401K plans. So, the next question we need to ask is: if a pilot’s 401K account hit the IRS maximum each year, could it ever be enough to replace that pension benefit?
For starters, we’re going to make a conservative assumption that a pilot only receives company contributions up to the IRS limit of $69,000 per year in their retirement accounts (401K and MBCBP). This is conservative enough to be absurd. This limit has increased by $1,000-$3,000 every year that I’ve been paying attention. It will most likely continue to increase in the future. I used $69,000 here because I felt lazy, but you can absolutely automate a 3-5% annual increase each year on your personal copy of our calculator.
The long-term return of the market is above 10.5%, but we’ll be conservative and leave some room for inflation by only assuming a long-term return of 5%. Investing that sum in a retirement account each year with those returns could potentially yield the following results:
| Year | Annual Contribution | Cost Basis | Total Value |
| 1 | $69,000 | $69,000 | $69,000 |
| 2 | $69,000 | $138,000 | $141,450 |
| 3 | $69,000 | $207,000 | $217,523 |
| 4 | $69,000 | $276,000 | $297,399 |
| 5 | $69,000 | $345,000 | $381,269 |
| 6 | $69,000 | $414,000 | $469,332 |
| 7 | $69,000 | $483,000 | $561,799 |
| 8 | $69,000 | $552,000 | $658,889 |
| 9 | $69,000 | $621,000 | $760,833 |
| 10 | $69,000 | $690,000 | $867,875 |
| 11 | $69,000 | $759,000 | $980,268 |
| 12 | $69,000 | $828,000 | $1,098,282 |
| 13 | $69,000 | $897,000 | $1,222,196 |
| 14 | $69,000 | $966,000 | $1,352,306 |
| 15 | $69,000 | $1,035,000 | $1,488,921 |
| 16 | $69,000 | $1,104,000 | $1,632,367 |
| 17 | $69,000 | $1,173,000 | $1,782,985 |
| 18 | $69,000 | $1,242,000 | $1,941,135 |
| 19 | $69,000 | $1,311,000 | $2,107,191 |
| 20 | $69,000 | $1,380,000 | $2,281,551 |
| 21 | $69,000 | $1,449,000 | $2,464,628 |
| 22 | $69,000 | $1,518,000 | $2,656,860 |
| 23 | $69,000 | $1,587,000 | $2,858,703 |
| 24 | $69,000 | $1,656,000 | $3,070,638 |
| 25 | $69,000 | $1,725,000 | $3,293,170 |
| 26 | $69,000 | $1,794,000 | $3,526,828 |
| 27 | $69,000 | $1,863,000 | $3,772,170 |
| 28 | $69,000 | $1,932,000 | $4,029,778 |
| 29 | $69,000 | $2,001,000 | $4,300,267 |
| 30 | $69,000 | $2,070,000 | $4,584,280 |
| 31 | $69,000 | $2,139,000 | $4,882,495 |
| 32 | $69,000 | $2,208,000 | $5,195,619 |
| 33 | $69,000 | $2,277,000 | $5,524,400 |
| 34 | $69,000 | $2,346,000 | $5,869,620 |
| 35 | $69,000 | $2,415,000 | $6,232,101 |
| 36 | $69,000 | $2,484,000 | $6,612,706 |
| 37 | $69,000 | $2,553,000 | $7,012,342 |
| 38 | $69,000 | $2,622,000 | $7,431,959 |
| 39 | $69,000 | $2,691,000 | $7,872,557 |
| 40 | $69,000 | $2,760,000 | $8,335,184 |
| 41 | $69,000 | $2,829,000 | $8,820,944 |
| 42 | $69,000 | $2,898,000 | $9,330,991 |
Note that a FedEx pilot doesn’t receive full pension benefits until reaching 25 years of total service. For our initial scenario, a pilot who invested themselves instead of relying on a pension would end up with $3,293,170 at 25 years. This is strikingly close to the $3.25M in total value we calculated by applying the 4% rule to the $130K annual payout under the current FedEx pension.
At a basic, perhaps overly-conservative level, this suggests that current IRS contribution limits provide a roughly equivalent replacement for a traditional pension. That makes sense to me.
This also says that if I had the choice between a pension and increased DC from my company, I might be safe choosing either.
Now, this doesn’t account for the fact that many airline pilots won’t reach 25 years of total service. Many retire early for medical reasons. Some have other things to do in life and just don’t stick around. Some started later in life. The pension only increases at 2.5% per year while we’re conservatively assuming that our investments grow at twice that rate. This suggests that anyone planning to retire with fewer than 25 years of service loses out with the pension.
It’s also critical to note that flying for longer than 25 years does nothing for a FedEx pilot. It will not increase their pension payout. A pilot hired at age 23 (and I fly with them regularly at my airline) will have a full 42 years to work at their airline. Financially, it would not make sense for that pilot, or any pilot starting at FedEx under the age of 40 to want the pension. They’d be leaving millions of dollars on the table.
One final way to view this data is that if you choose to work for more than 25 years, or if you let your personal retirement savings sit for more than 25 years before you dig into them, the 4% Rule will allow you to spend a higher dollar amount per year than what your peers will get with their pension after the same number of years at their company.
It’s starting to look like that pension isn’t such a great deal for a lot of pilots. Let’s not stop there though.
Pension Valuation, Part 3 – Beyond the 4% Rule
Remember how the Trinity Study showed the 4% rule to be extremely conservative? In many cases, a retiree can safely spend far more than 4% of their nest egg’s initial value each year without ever running out of money. It might not be reckless or unrealistic for a pilot to plan on spending 6%, 8% or even more of our nest egg each year in retirement without running out of money, especially if that pilot had other savings.
If we were to use a 6% or 8% rule, we’d need to re-calculate the value of the FedEx pension. Here’s what those numbers look like:
| FAE Cap | Annual Payout | 6% Rule Equivalent | 8% Rule Equivalent | |
| Current Contract | $260,000 | $130,000 | $2,166,667 | $1,625,000 |
| TA1 MBCBP Opt-In | $290,000 | $145,000 | $2,416,667 | $1,812,500 |
| TA1 Cap Increase | $338,000 | $169,000 | $2,816,667 | $2,112,500 |
These scenarios drastically change the value proposition of the FedEx pension.
Using a 6% rule, a FedEx pilot could potentially save up a nest egg equivalent in value to their pension after just 19 years of investing. An 8% rule puts this break-even point at 15 years.
Even under the maximum TA1 FAE cap of $338,000, a 6% rule would break even at 22 years, while an 8% rule would break even at 19 years.
This means that if a pilot wants to retire before 25 years of total service (or worries they may be forced to retire early) they’ll hit that target annual retirement income far more quickly by investing in a 401K/MBCBP than by relying on the pension.
These implications are even more important for pilots who plan to stick it out for the full 25 years. Why would you stick with a program that only pays the same $169,000 after 30 or 40 years of working that it also pays after 25 years of working, when you could save up that much on your own with just company DC in 19 years?
If you choose anything less ridiculously conservative than a 4% rule, or is you expect overall market returns above 5%, you’d be leaving a lot of money on the table by choosing to stay with the pension plan while working at FedEx for a full 25 years.
If this section didn’t rock your world, you need to go back and reread it until it does.
It’s very likely that a pilot would end up with far more money overall investing company contributions into their own 401k than they could ever hope to get from a legacy pension plan.
Case Study Conclusion
In my ever so humble opinion, I believe this should permanently conclude the discussion on whether 401k plans are better than legacy pension plans. These numbers include a lot of assumptions, but they’re fairly conservative overall.
I’d love for you to try running your own numbers though. Here’s a link to the spreadsheet I used for this case study. (You have to download your own copy. Don’t ask for permissions to edit mine.)
I’d also love for you to run numbers until you’re confident with them, then send your calculator to your Certified Financial Advisor as setup for a live discussion. If you do this, I think they’ll agree on the math.
As with all things related to aviation, there are plenty of “it depends” caveats here. First, different assumptions produce different results. That’s why you get to download your own calculator. There are also some other negative characteristics of pension plans that bear discussing here. The biggest problem with pensions is that they usually aren’t heritable.
For our purposes, money being “heritable” means your descendants get that money if you die. Although some legacy pension plans allow the spouse of a deceased pilot to continue receiving at least some benefits, that’s usually the end of the line. Once both spouses are gone, their kids get nothing.
That sucks.
Modern retirement accounts are the exact opposite. If your 401k has $1M the day you die, your kids can inherit $1M, and some or all of the tax advantages associated with that retirement account.
Remember: the Trinity Study showed that in most cases using The 4% Rule, a retiree’s account had more money in it at death (assumed at age 90) than it had when the reitree started withdrawing money at age 60!
If a 401k plan receiving $69,000 per year in contributions grows to exactly the same $3.2M in value after 25 years that a pension is worth, the 401k is vastly superior for anyone who wants to pass anything on to their heirs.
One final detail makes all the difference here for me. Part of the reason senior airline pilots lost their pension is that those plans are considered an asset of the parent company and subject to creditor claims in bankruptcy. Given the history of the airline industry, this would leave me terrified if I worked at a company that still offered a legacy pension. The most fundamentally important thing about a 401k account (and partially true about a MBCBP) is that the money in that account belongs to the individual. The company doesn’t control it, and creditors can’t go anywhere near it if your company declares bankruptcy.
Although many pension plans end up under-funded and in trouble, it appears that at least the FedEx pension plan is well-funded for the time being. That’s great…unless, God forbid, the worst were to happen and creditors got access to those funds. If a company were suddenly unable to cover their debts, and creditors started taking whatever they could get, an over-funded pension plan would be ripe for the picking.
Many pilots got screwed in airline bankruptcies of the early 2000s. Nothing will ever restore what is lost, and that’s wrong. However, for anyone going forward, a 401k plan offers at least as much money as a legacy pension plan, and potentially far more. Also, that money can be passed on to your children, unlike pension payments. Most importantly, that money can’t be taken from you in the event of a corporate bankruptcy. I cannot think of a reason that I’d advocate for a legacy pension plan over a 401k.
This concludes Part 1 of our pension discussion. Some details of the FDX retirement plans bear further discussion. If you care to read about them, check out Part 2. Otherwise, thanks for reading.
Thanks to Piret Ilver on Unsplash for this post’s feature image!
I’m not advocating for pensions but one advantage with them “maxing” out at 25yos and 60 years old is there is less incentive to work until 65(or 67). In a senority based profession, older guys retiring earlier potentially means more earning potential and/or QOL gains for everyone junior to them.
That’s a great point. I wonder how many of those pilots are doing that, rather than hanging on until 65. I worry that too many of us are working ourselves to death. I aspire to buck that trend, though the money will make it tough.