With contract openers being exchanged in the near future, everyone seems to be talking about what we Delta pilots should be getting in our next contract. Everyone has their areas they would like to see improved. Pay, scope and retirement seem to be at the top of the list. Today we will look more in-depth at the Delta Pilots Defined Contribution (DC) plan to see how it stacks up against the old Defined Benefit (DB) plan it replaced.
A Little History
Without getting into the weeds, the old DB pension plan paid a percentage of your final earnings for the rest of your life. When most of today’s pilots at Delta were hired they expected to receive 60% of their final average earnings during retirement. Now newly hired pilots enter a different retirement system: a Defined Contribution (DC) plan (it is not technically a DC plan, but it acts almost the same way). It pays 15% of the pilot’s earnings into their 401K. Since these plans are so different it is hard to make a direct comparison, but we will work through an example to see how they stack up.
We will assume our pilot was hired young enough to have a 30-year career. During this career he will spend 8 years as an A320 First Officer, 7 years as an A330 First Officer, 8 years as an A320 Captain and 7 years as an A330 Captain. We will also assume he gets paid 80 hours a month and profit sharing is 10% per year. We will do this whole example in “real” terms, meaning we will work in today’s dollars and assume inflation will have the same effect on all scenarios. This means that the hourly rates are increasing with inflation each year. We will also assume our pilot gets a real return of 5.6% per year—this is the historical real return of a 60/40 portfolio of the S&P 500/5 year US Treasury Notes (an 8.71% nominal return).
Depending on who you are and where you sit, these can look like very optimistic assumptions or very pessimistic. Obviously I could have used any range of assumptions, but we will go with these and see how they work.
Our pilot in this example would retire off the A330 and his final average earnings (FAE) would be $269,575.68 (again this in in today’s dollars – the nominal FAE with 3% inflation for 30 years would be $654,330.93). Under the old DB plan he would be entitled to receive 60% of his FAE or $161,745 for the rest of his life. There were other options available to him (50% survivor benefit for example), but we will keep it simple with the single life annuity. The cost of a single life annuity starting at age 65 to get an annual payout of $161,745 for the rest of his life is $2,468,498 (check out immediateannuities.com).
In other words, we would have to save $2,468,498 to buy the same annuity the old DB pension would have provided. Unfortunately the 15% contribution in the new DC plan isn’t going to cut it. Using the real return mentioned above of 5.6% he would have saved only $1,917,760. This would buy him an annuity only providing him with 47% of FAE. To get to the 60% mark, Delta would have to increase the contribution to 19% of earnings!
But this isn’t the whole story. In our example we received a constant real return of 5.6% per year. In the real world there is nothing constant about investing in risky assets. As I mentioned above the 60/40 portfolio of S&P 500/5 year Treasury Notes had a real return of 5.6%, but it also had a standard deviation of 11.53%. If we take the volatility of the returns into account the picture looks even worse. I ran a Monte Carlo simulation using the return and standard deviation of our portfolio with Delta contributing 19% into the 401K. Basically, instead of assigning a constant rate of return every year, it was a random number generated using the statistics of the portfolio. If you remember the bell curve from statistics, most of the returns fell under the fat part of the curve, but some years the returns were really good and others were really bad. After assigning a random return for each year, I can calculate if there was enough money saved to buy the annuity which provides the 60% FAE. I then run through the calculation 1,000 times to see what percentage of the time I have enough money to buy that 60% FAE annuity. With Delta contributing 19% he actually only had a 58% chance of having enough money to buy the 60% FAE annuity. If he wanted to be more confident – say 90% – that he would be able to buy that 60% FAE annuity, Delta would have to contribute 28% of his earnings to the 401K!
So as you can see, even with a pretty good career and a decent rate of return, we still are pretty far from having as valuable a retirement situation as it used to be. This difference now has to be made up by saving more in our 401K’s ourselves, which of course decreases our take home pay. To get to that 90% confidence level above he would have to contribute 13% of his income to his 401K right from day 1, in addition to the 15% Delta provides.
I can hear all the non-pilots who read this blog really crying for us right now, since this is a better situation than most people are in these days. Be that as it may, I hope increasing retirement funding is a priority in the next contract.