401(h) Plan Rules: What Business Owners and Advisors Need to Know

Plan document language

The underlying qualified pension or annuity plan must contain provisions that establish the 401(h) account, describe the retiree medical benefits to be paid, define the participant group, and address how the account is funded, invested, and administered. Without proper plan document language, the 401(h) feature simply does not exist, regardless of intent.

• Explicit establishment of the 401(h) sub-account.
• Definition of qualifying retiree medical benefits.
• Eligibility and benefit-class language.
• Funding and forfeiture mechanics.

Separate accounting

The 401(h) portion of the plan must be separately accounted for. Contributions, earnings, and benefit payments allocable to the 401(h) account cannot be commingled with general retirement assets in a way that defeats the separation requirement. The trust may pool assets for investment, but the books must distinguish the 401(h) component at all times.

The incidental-benefit rule

Medical benefits provided under Section 401(h) must be subordinate — incidental — to the retirement benefits provided by the plan. This is most often tested by comparing aggregate contributions for medical benefits to aggregate contributions for retirement benefits over the life of the plan. Plan design must respect this ceiling on an ongoing basis, not just at adoption.

Nondiscrimination

401(h) benefits are subject to the applicable nondiscrimination requirements based on the participant group and plan design. The retiree medical benefit cannot be structured to disproportionately favor highly compensated employees relative to the rules that apply to the underlying plan. Coverage testing, benefit testing, and the definition of the covered class all matter.

Funding considerations

Funding the 401(h) portion is an actuarial exercise tied to the plan's overall funding methodology and the projected stream of retiree medical benefits. There is no single statutory dollar limit; instead, the actuary models reasonable, level funding for the defined benefit stream and the medical benefit stream together, subject to the incidental-benefit ceiling.

Ongoing administration

401(h) is not a 'set it and forget it' feature. Annual valuations, Form 5500 reporting, fiduciary oversight of investments, claims processing for medical reimbursements, and periodic plan-document restatements all apply. Most failures advisors see in practice come from neglecting one of these ongoing items.

• Annual actuarial valuation including the 401(h) component.
• Form 5500 disclosures consistent with the plan's structure.
• Documented procedures for medical claims and reimbursements.
• Periodic restatement to keep plan language current.