APRIL 2, 2020
Recently, many of our colleagues have received inquiries about “401(h) plans.” A 401(h) is not a type of plan but rather an ancillary benefit of a defined benefit plan. A 401(h) account provides a highly efficient way to fund retiree health benefits. Contributions to the account are tax-deductible, earnings on the account grow tax-free, and health benefits paid from the account are not taxable to retirees if used on qualified medical expenses. The account can be considered similar to a health savings account with higher limits. But there are limitations that may make it difficult or impossible for an employer to utilize a 401(h) account. This article summarizes the requirements, advantages, and disadvantages of Section 401(h) accounts.
In 1962, Congress added Section 401(h) to the Internal Revenue Code. Subsequent regulation describes the conditions that must be satisfied to preserve the tax-qualified status of a pension plan that includes a 401(h) account and when an employer’s contributions to a 401(h) account are deductible. These regulations have not been revised since they were issued 58 years ago.
Section 401(h) provides that, if certain conditions are satisfied, a “pension plan may provide for the payment of benefits for sickness, accident, hospitalization, and medical expenses of retired employees, their spouses and their dependents.” A 401(h) account can be established as part of any “pension” plan, including both a traditional defined benefit pension plan, Cash Balance Plan, Fully Insured Plan and/or a Money Purchase Pension Plan. The following conditions for establishing a 401(h) account are described in Treas. Reg. §1.401-14.
Specified benefits. The plan must specify the health benefits that will be available and must include provisions for determining the amount that will be paid. The employer’s contributions to the 401(h) account must be “reasonable and ascertainable.” This requirement will not be satisfied unless the terms of the 401(h)-plan amendment specify the amount of benefits and the time period with respect to which benefits will be paid. The plan may not allow for employer discretion in the timing and amount of benefit payments from the 401(h) account.
Separate account. A separate account must be maintained for contributions used to fund the health benefits. The separation is for recordkeeping purposes only; the 401(h) funds need not be separately invested but may be separately invested. It appears that a 401(h) retiree health account may operate as a pooled reserve that pays health benefits for all covered participants/retirees (similar to a defined benefit plan) or may include separate retiree health accounts to provide health benefits for each participant/retiree under the plan (similar to a defined contribution plan).
Neither the law nor the regulations address how the separate account should be designed.
BY Maxwell A. Coulliette CFP®, CLU, ChFC, CEA, CRPS®1225 E. Ft. Union Blvd Ste 350, Cottonwood Heights, UT 84047
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