Can You Tap a 401(h) Account While Still Working? What the IRS Said About Age 59½

There's a wrinkle in the 401(h) rules that trips up a lot of otherwise well-designed plans. The retiree medical account inside a pension plan is built to pay medical costs for retired employees. That word — retired — is doing a lot of work. It seems to draw a clean line: separate from your employer first, then the account can reimburse your qualified medical expenses.

But retirement doesn't always mean walking out the door anymore. A pension plan can pay benefits to someone who has reached age 59½ even if they're still on the payroll. So a natural question follows: if a participant is old enough to start drawing their pension while still employed, can that same still-working participant also receive tax-free medical reimbursements from the plan's 401(h) account?

The IRS has now answered that question — favorably — more than once. Here's what the rulings say, and, more importantly, the design detail that determines whether the answer applies to your plan.

A 401(h) account is a separate account inside a defined benefit, cash balance, or money purchase pension plan. It funds medical benefits — sickness, accident, hospitalization, and general medical expenses — for retired employees, their spouses, and their dependents. Reimbursements come out income-tax-free, which is what makes the structure so attractive for high-income business owners and professionals.

To keep the whole pension plan qualified, the retiree medical account has to follow a specific set of guardrails: separate accounting, defined benefit terms, and the subordination limit that caps how much of the plan's contributions can go toward medical benefits. And running underneath all of it is that eligibility rule — the account is supposed to pay medical benefits only for people who are retired.

For decades, "retired" was read the way you'd expect: you had to be separated from service. That reading created the tension the IRS had to resolve.

Modern pension plans are allowed to let participants begin receiving retirement benefits once they reach age 59½ — no separation required. A participant can still be showing up to work full-time and simultaneously collecting pension payments.

If that person counts as "retired" for medical-account purposes, the 401(h) account can reimburse their medical expenses right now, while they're still employed. If they don't count as retired, the account has to wait until they actually leave.

That's the fork in the road the IRS addressed.

In a private letter ruling issued in early 2023 (PLR 202305001), a pension plan had been amended to let active participants begin drawing pension benefits once they turned 59½. The plan sponsor asked whether letting the 401(h) account reimburse those still-working participants' medical expenses would blow up the plan's qualified status.

The IRS said it would not. Its reasoning: because these participants were eligible to receive pension benefits under the plan's terms, they met the definition of "retired employees" for medical-account purposes — even though they hadn't separated from service. Being eligible to draw the pension was enough.

That was a meaningful clarification. There has been very little official guidance on 401(h) accounts since the provision was created back in 1962, so plan sponsors and administrators have leaned heavily on the handful of letter rulings that exist. This one directly connected the in-service pension distribution rules to the retiree medical account eligibility question and lined them up in the taxpayer's favor.

Here's the part to underline for anyone drafting or amending a plan.

The IRS was explicit that the answer turns on how the plan defines eligibility for pension benefits. In the ruling, a participant became eligible to start their pension at 59½ without having to separate from service. That's why they qualified as "retired" for the medical account.

Flip that design, and the answer flips too. If the plan says a participant can only receive pension benefits after separating from employment, then a still-working participant is not eligible for the pension, is not "retired" under the account rules, and the 401(h) account cannot reimburse their medical expenses while they keep working.

In other words, this is a plan-drafting outcome, not an automatic feature. Whether a given participant can access the medical account while employed depends entirely on whether the plan document makes pension benefits available to them at 59½ without a separation. Two plans with identical 401(h) accounts can land in opposite places based on that single provision.

If the 2023 ruling were the only word on the subject, you'd read it as an interesting but isolated data point. It isn't. The IRS has since issued additional rulings on the same fact pattern — including one at the end of 2025 (PLR 202551032) — reaching the same conclusion: participants who elect to start pension benefits at the eligible age while still employed qualify as retired employees for medical-account purposes.

One later ruling pushed the logic a step further, blessing medical reimbursements even for participants who had elected to receive their entire vested pension benefit through the in-service option. So the IRS position has held steady across several rulings and shown some willingness to extend it.

That consistency is worth something. Even though no single letter ruling is binding beyond the taxpayer who requested it, a repeated, uniform position gives you a clear read on how the IRS is currently thinking about this.

The practical value shows up for the participant who wants to keep working past 59½ but is facing real medical costs — insurance premiums, out-of-pocket expenses, the kind of spending that adds up in your 60s. If the plan is designed to make pension benefits available at 59½ without separation, that participant can pull tax-free dollars out of the medical account without having to retire first, and without waiting.

For a business owner or professional running a defined benefit or cash balance plan with a 401(h) feature, that's a genuine flexibility gain. It decouples "I want to start using my medical account" from "I have to stop working."

A few honest limitations, because this is an area where overreading the guidance can get you in trouble:

• Private letter rulings aren't precedent. Only the taxpayer who requested a given ruling can formally rely on it. You can't cite these as binding authority for your own plan. They're a window into IRS thinking, not a rule you can bank on in an audit.

• Every one of these rulings rested on a "no transfer" representation. In each case, the taxpayer represented that the 401(h) account had not been funded with pension assets moved over under the excess-asset transfer rules. That representation was part of the foundation. A plan that funded its medical account through those transfers is not squarely within the facts the IRS blessed.

• The design detail isn't optional. Everything above depends on the plan making pension benefits available at 59½ without separation from service. Get that provision wrong and none of the favorable analysis applies to your participants.

• This is unsettled enough that individualized advice matters. With so little formal guidance in this corner of the law, a plan sponsor considering this feature should be working with an actuary and ERISA counsel to confirm the plan language actually delivers the result — ideally before anyone relies on it.