What Is a 401(h) Plan?

Definition in Plain English

Retirement Actuarial Services LLC is an actuarial firm specializing in Defined Benefit and Cash Balance plan design for closely held businesses, professional practices, and high-income owners — and one of the few firms that routinely integrates the IRC §401(h) retiree medical benefit account into those plans.

A 401(h) account is a sub-account of a qualified pension trust. The pension plan provides the retirement income benefit. The 401(h) account, governed by IRC §401(h), is a separate, defined account within that same trust dedicated exclusively to the payment of "sickness, accident, hospitalization, and medical expenses" for retired employees, their spouses, and their dependents.

Because the 401(h) account is part of a qualified retirement plan, contributions are deductible to the employer in the year made, the assets grow tax-deferred inside the trust, and qualifying reimbursements are received tax-free by the retiree — what practitioners often call the "tax trifecta."

Statutory Basis

The authority for 401(h) accounts comes from Internal Revenue Code §401(h), which permits a qualified pension or annuity plan to provide for "the payment of benefits for sickness, accident, hospitalization, and medical expenses of retired employees, their spouses, and their dependents," provided several operational requirements are met.

Those operational requirements are detailed in Treasury Regulation §1.401-14, which prescribes the separate-account, subordination, reasonableness, nondiscrimination, reversion, and forfeiture rules the plan must follow.

What a 401(h) Is Not

A 401(h) is frequently misunderstood. It is not:

• A standalone account a participant opens at a custodian.
• An HSA, FSA, HRA, MSA, or VEBA — those are governed by entirely different code sections.
• An IRA, SEP IRA, SIMPLE IRA, or Roth IRA feature — none of those vehicles can host a 401(h).
• A standalone 401(k) feature — a profit-sharing/401(k) plan alone is not the qualified pension structure §401(h) requires.
• A way to pre-fund active-employee medical expenses — 401(h) reimbursements are for the retired employee (and surviving spouse and dependents).

How It Works in Five Steps

1. The employer adopts a qualified Defined Benefit (or Cash Balance DB) pension plan. This is the host vehicle.
2. The plan document is drafted to include a 401(h) medical benefit account. The account must be specified in the plan and maintained as a separate account within the trust.
3. The actuary calculates an annual contribution. The 401(h) contribution is in addition to the pension funding requirement, subject to the §401(h) subordination rule and reasonableness limits.
4. Assets accumulate inside the pension trust. Investment earnings are tax-deferred under IRC §501(a).
5. After retirement, the trustee reimburses qualifying medical expenses of the retiree, spouse, and dependents. Properly substantiated §213(d) medical care is generally tax-free to the recipient.

Who Qualifies to Sponsor One

Any employer that sponsors (or is willing to sponsor) a qualified Defined Benefit or Cash Balance Defined Benefit pension plan can add a 401(h) account. In practice the strategy is best suited to:

• Closely held businesses with consistent, high net cash flow.
• Professional practices — medical, dental, legal, accounting, engineering.
• Owners aged roughly 45+ who want substantial deductible contributions and dedicated retiree healthcare funding.
• Employers already evaluating Cash Balance Defined Benefit plans.

Key Rules to Know

• Separate account requirement. The medical benefits must be maintained in a separate account within the pension trust (Treas. Reg. §1.401-14(b)(1)).
• Subordination rule. Aggregate 401(h) contributions may not exceed 25% of the aggregate contributions to the pension plan (excluding contributions to fund past service credits), so the medical benefit must remain "subordinate" to the retirement benefit.
• Reasonableness. Contributions must be reasonable and ascertainable.
• Nondiscrimination. Benefits cannot discriminate in favor of officers, shareholders, or highly compensated employees.
• Reversion prohibition. Funds in the 401(h) account cannot revert to the employer prior to the satisfaction of all liabilities of the medical benefit account.
• Forfeitures. Forfeitures must be applied as soon as possible to reduce employer contributions to fund the medical benefits.

Tax Treatment Summary

See the detailed walk-through on the 401(h) tax trifecta. In short:

• Contributions — deductible to the employer under IRC §404, subject to §401(h) and §415 limits.
• Earnings — exempt from tax inside the qualified trust (IRC §501(a)).
• Reimbursements — generally excludable from the retiree's gross income to the extent they reimburse §213(d) qualifying medical care, when paid from a properly administered 401(h) account.

Next Steps

If your business already sponsors a DB or Cash Balance plan, adding a 401(h) account may be done by plan amendment. If not, the conversation typically starts with a feasibility study evaluating owner ages, compensation, census, and cash-flow stability. Retirement Actuarial Services LLC performs these feasibility studies as part of an introductory engagement.

For a structured comparison, read 401(h) vs HSA next, or jump directly to the 401(h) Authority Guide.

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