How Actuaries Calculate 401(h) Contribution Limits

One of the first questions people ask about 401(h) accounts is the simplest one: "How much can I put in?"

With a 401(k), the answer is a number you can look up. With an IRA, same thing. But with a 401(h) account, the answer is: "It depends — ask the actuary."

That answer frustrates people, so this article explains what the actuary is actually doing, why the rules work this way, and roughly what the numbers look like in practice. No jargon, no formulas — just the logic.

A 401(h) account doesn't have a dollar limit printed in the tax code. Instead, the rules say the contributions must be reasonable and ascertainable.

Those two words do a lot of work, so let's translate them:

• Reasonable means the contribution has to be based on a genuine estimate of what your retiree medical benefits will actually cost. You can't just pick a big number because you'd like a big deduction.
• Ascertainable means the amount has to be calculated — derived from real assumptions about real costs, in a way someone else could check. It can't be vague or made up as you go.

In other words: the contribution limit isn't a number, it's a method. And the person who runs the method is an actuary.

The actuary's job is to answer one question: What will it cost to pay this person's medical benefits in retirement, and how much do we need to set aside each year to get there?

Think of it like planning for a known future bill. The actuary works through four steps:

• Step 1: Estimate the retirement medical bill. The actuary starts with what healthcare will cost you once you retire — Medicare premiums, the income-based surcharges high earners pay, a Medicare supplement policy, drug coverage, dental, vision, hearing. For a high-income retiree, this often runs $15,000 to $30,000 per year, and more for a couple.

• Step 2: Stretch it over your retirement. Next comes how long you'll be paying that bill. If you retire at 65 and the projections say you'll live into your late 80s, that's 20-plus years of medical costs. And medical costs don't sit still — the actuary builds in healthcare inflation, which historically runs hotter than regular inflation. A $20,000 annual bill today can look like $35,000 or more twenty years from now.

• Step 3: Discount it back to today. The money in the account will be invested and will grow between now and retirement, so the actuary doesn't need to set aside the full future amount. Expected investment growth gets factored in, which shrinks the target.

• Step 4: Spread the funding over your working years. Finally, the actuary divides the target into level annual contributions between now and your retirement date. Someone funding over 15 years contributes less per year than someone funding over 7 — the shorter the runway, the bigger the annual amounts.

The output is your contribution: a calculated, documented, defensible number. That's what "reasonable and ascertainable" looks like in practice.

Take a 52-year-old physician planning to retire at 65. The actuary projects that she and her husband will spend about $30,000 per year on premiums and medical costs in retirement, rising with healthcare inflation over roughly 25 years of retirement.

After projecting those costs forward, crediting expected investment growth, and spreading the result over her 13 remaining working years, the actuary might land on annual 401(h) contributions somewhere in the range of $25,000 to $40,000 per year — every dollar of it deductible to her practice.

Treat those numbers as illustration, not quotation. The real figures swing meaningfully based on age, retirement date, health cost assumptions, and the design of the pension plan the account sits inside. Which brings us to the ceiling.

There is one hard limit layered on top of the actuary's calculation, and it's called the subordination test.

The rule says the medical benefits must be subordinate — secondary — to the retirement benefits. The plan exists to provide a pension first; the 401(h) account is a passenger, not the driver. In practice, this means contributions to the medical account generally can't exceed 25% of the total contributions going into the plan. Put another way: for every $3 going toward retirement benefits, no more than $1 can go toward medical.

This is why a 401(h) account is always part of a bigger plan-design conversation. A well-funded cash balance or defined benefit plan creates room for substantial 401(h) contributions. A thin pension creates a thin medical account. The actuary tests this ratio every year, and it's a cumulative test — the plan's whole history counts, not just the current year.

If you're the business owner, one more rule usually applies to you personally. Owners and certain officers are treated as "key employees," and the law requires their medical benefits to be tracked in a separate individual account. Contributions to that separate account count against the annual limit on defined contribution additions — the same limit that governs your 401(k) and profit-sharing contributions.

Translation: your own 401(h) contributions may compete for space with your other retirement contributions. This doesn't kill the strategy, but it absolutely has to be modeled up front, because the trade-offs differ from one owner to the next.

It's tempting to see all this machinery — actuaries, assumptions, annual testing — as bureaucratic overhead. It's better understood as the guardrail that keeps the whole arrangement safe.

The 401(h) account offers a remarkable deal: deductible contributions, tax-free growth, tax-free payouts for medical care. Deals that good attract abuse, and over the years some promoters have pushed aggressively overfunded medical accounts designed mostly to manufacture deductions. Those schemes are exactly what the reasonable-and-ascertainable standard exists to prevent — and exactly what draws unwanted attention when it's ignored.

A properly funded 401(h) account is the opposite of a scheme. Every contribution ties back to a documented projection of real medical costs. The assumptions are ones an outside reviewer would recognize as sensible. The paper trail exists before anyone asks for it. That discipline is what lets you take the deduction with confidence and sleep well afterward.

There's no lookup table for 401(h) contributions because the law wants each account funded against a real forecast of real medical costs — nothing more, nothing less. The actuary builds that forecast, spreads it over your working years, and checks it annually against the rule that keeps medical benefits secondary to your pension.

For a high-income business owner with a strong pension plan, the resulting numbers are often substantial — frequently rivaling what an HSA could accumulate over decades, compressed into a much shorter funding window.

If you want to know what your number would be, that's a plan design conversation. It starts with your age, your retirement date, and an honest projection of your healthcare costs — and it's exactly the work we do every day.