The 401(h) Account and Tax-qualified Plans: What is it? Why should You have one?

What is a 401(h) Account?

A 401(h) account comes from Section 401(h) of the Internal Revenue Code.  It provides for specific accounts, which are separately funded and managed, to be created for the reimbursement of eligible out-of-pocket medical-related expenses during retirement.

The list of qualified benefits, or expenses, in the Internal Revenue Code is quite extensive.  For example:

  • Elective Cosmetic Surgery Procedures
  • Spa and Fitness Programs
  • Lasik Eye Surgery
  • Designer Eyeglass Frames
  • And much, much more . . .

In essence, the 401(h) is a medical expense account to alleviate the financial burden of health conditions, accidents and hospitalizations, which individuals, and ANY tax dependent (spouse, parents, grandparents, special needs child, etc.) may experience during retirement.  It’s a part of the employer’s custom designed tax-qualified plan.

How a 401(h) Plan Works

  • The employer makes fullly tax-deductible contributions to the Plan.
  • Funds deposited into 401(h) plans are allowed to grow income tax-free.
  • Upon retirement, funds withdrawn by beneficiaries for eligible out-of-pocket medical expenses are income tax-free.

Three Specific Tax Advantages

  1. Employer contributions to a 401(h) account (like contributions to fund retirement benefits) are deductible in the year contributed under Code Section 404.
  2. Earnings on the 401(h) account contributions accumulate income tax-free in the trust (based on the tax-exempt status of the trust under normal retirement plan rules).
  3. Distributions – principal and earnings – from the 401(h) account to pay for retiree health benefits are not taxable to the retirees under Code Section 105 or 106.  This means that the earnings on the 401(h) account never become taxable as opposed to the earnings for retirement benefits.

There are also non-tax advantages to using a 401(h) account to fund retiree health benefits. 

For example, Statement No. 106 of the Financial Accounting Standards Board (FASB) requires a sponsor of those benefits to accrue the expected cost of providing retiree health benefits.  This amount is required to be recognized in part as a liability and in part as a current expense on the sponsor’s financial statements.

Under FASB Statement No. 106, amounts contributed to a 401(h) account reduce the amount of liability and expense that must be recognized on the financial statements.

For pension plan sponsors who provide, or are thinking about providing, retiree health benefits, a 401(h) account should always be used to pre-fund the obligations.   

The 401(h) account is an impressively more efficient vehicle for funding retiree health obligations than any other method.

Unused 401(h) contributions carry forward indefinitely.

The Why of a 401(h) Account

Ever since the federal government got involved in providing healthcare, especially through the Affordable Care Act, better known as “Obamacare,” the industry has been in upheaval. 

Today, there’s talk of a “Medicare for All” plan with the elimination of private sector health insurance companies.  Regardless of government involvement of this nature, 401(h) accounts could well be most advantageous for retirees. 

The main advantage of a 401(h) account would be the ability to pay for critical healthcare benefits that have been cut.  Perhaps, the ability to pay for part or all prescription drugs that are not covered.

Your Next Step . . . Find out More!

Learn how a 401(h) account as part of a custom designed tax-qualified plan may benefit your company or partnership.

Schedule a FREE telephone consultation with Rick English by phone or email:

Telephone: (817) 312-1032

Email: [email protected]

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