Are 401(h) Contributions Mandatory?

Business owners are rightly cautious about anything that looks like a permanent obligation. Pension plans already come with required annual funding, so when owners hear about adding a 401(h) account for retiree medical benefits, the first question is often a practical one: "Am I locking myself into another mandatory contribution every year?"

Good news. The answer is no — and the way the contribution limit works actually turns skipped years into an advantage. Let's walk through both pieces.

A 401(h) account lives inside a pension plan, such as a defined benefit or cash balance plan. The pension side of that plan does come with funding requirements — that's the nature of a pension, and your actuary calculates what's due each year.

The 401(h) account is different. Contributions to the medical account are optional. There is no rule that forces you to fund it every year, and no penalty for contributing nothing at all in a given year. Think of it as a funding opportunity that sits alongside your pension, not a second obligation stacked on top of it.

In practice, that means the medical account can flex with your business:

• Great year? Fund the pension and make a healthy 401(h) contribution too, capturing the deduction while cash flow is strong.
• Tight year? Fund the pension as required and skip the 401(h) contribution entirely. Nothing bad happens. The account simply sits, invested, waiting for the next contribution.
• Somewhere in between? Contribute a partial amount. The choice is yours each year, within the limits your actuary calculates.

One practical note: this flexibility should be reflected in how your plan is written. A well-drafted plan describes the medical benefits and how contributions are determined without chaining you to a fixed amount every year. That's standard drafting for a firm that works with these accounts regularly — but it's worth confirming, because the document controls.

Here's the part that surprises people, and it's where the 401(h) rules are genuinely friendly.

The main limit on 401(h) funding is often described as a 25% rule: contributions to the medical account can't exceed 25% of the total contributions going into the plan. Said another way, for every $3 that goes toward retirement benefits, up to $1 can go toward the medical account.

What most people miss is that this test is cumulative. It doesn't reset every January. Instead, it looks at all the contributions made since the medical account was established — every pension dollar and every medical dollar, added up across the years.

That changes what a skipped year means. When you fund your pension but skip the 401(h) contribution, you aren't losing that year's medical room. You're banking it.

A simple example makes it click. Suppose your cash balance plan receives $200,000 in pension contributions each year:

• Year 1: You contribute $200,000 to the pension and nothing to the 401(h) account. Your cumulative pension contributions are $200,000, which would have supported roughly $66,000 of medical contributions. You used none of it — so that room carries forward.
• Year 2: Another $200,000 goes into the pension. Your cumulative base is now $400,000, supporting roughly $133,000 of total medical contributions to date. You've contributed zero so far, so the full amount is available.
• Year 3: Business is strong and you want to catch up. Instead of being limited to one year's worth of medical funding, you can make a much larger contribution — using the room that quietly accumulated during the years you sat out.

The exact figures in any real plan come from your actuary, who also has to confirm the contribution matches your projected retiree medical costs. But the direction is exactly as shown: patience enlarges the limit.

Compare that to how most tax-favored accounts work. Skip a year of 401(k) contributions and that year's opportunity is gone forever. Skip a year of 401(h) contributions and the opportunity waits for you — and every pension contribution you make in the meantime makes it bigger.

We always tell you where the edges are, so here they are.

First, the banking only works while the pension is being funded. The cumulative limit grows because pension contributions keep flowing in. If your plan becomes fully funded and pension contributions stop, the medical account's room stops growing too — and a plan contributing nothing toward retirement generally can't accept new medical contributions at all. Flexibility is real, but it lives inside an active, contributing plan. Owners planning to wind a plan down soon shouldn't count on "catching up later," because later may not come.

Second, optional doesn't mean unlimited. The cumulative 25% test is the ceiling, not the target. Every contribution still has to be justified by a genuine calculation of your projected retiree healthcare costs — that's the actuary's job, and it's what keeps the account safe. The banked room tells you what's possible; the actuarial math tells you what's appropriate.

No — 401(h) contributions are not mandatory. The account asks nothing of you in lean years and rewards you in strong ones, and the cumulative limit means the years you skip quietly enlarge the contributions you can make later. Among tax-advantaged accounts, that combination of flexibility and forgiveness is rare.

The smart move is simply to have the account in place early, so the clock on your cumulative limit starts running while your pension contributions are building the base. Whether you fund it aggressively, occasionally, or not yet at all remains your call, year by year.

If you'd like to see what your plan's cumulative 401(h) room looks like — or what it could look like a few years from now — that's a quick calculation, and we're happy to run it with you.