How to Maximize Your 401(h) Contributions

If you've been searching for a way to set aside money for medical expenses in retirement — and get a tax deduction for doing it — the 401(h) account deserves a close look. It's one of the most overlooked tools in retirement planning, and when it's structured correctly, it can allow for substantial tax-deductible contributions that grow tax-free and come out tax-free when used for qualified medical expenses.

But here's the catch: how much you can actually contribute to a 401(h) depends heavily on how you set it up. Two business owners with identical incomes could end up with dramatically different 401(h) funding capacity based on one structural decision. This article walks through what a 401(h) is, why that structural decision matters so much, and how to position yourself for the largest contributions possible.

A 401(h) is a special account designed to pay for medical expenses in retirement. Think of it as a medical expense fund that lives inside your retirement plan.

Here's what makes it so attractive from a tax standpoint:

Contributions are tax-deductible. Money your business puts into the account reduces your taxable income today, just like a contribution to a traditional retirement plan.

Growth is tax-free. The investments inside the account grow without being taxed along the way.

Withdrawals are tax-free — as long as the money is used for qualified medical expenses in retirement. That includes things like health insurance premiums, Medicare premiums, prescription drugs, dental work, vision care, and long-term care costs.

That triple tax benefit — deductible going in, tax-free growth, tax-free coming out — is rare. A traditional retirement plan gives you the first two, but withdrawals are taxed. A health savings account (HSA) offers all three, but with much smaller contribution limits. The 401(h) can offer that same triple benefit at a much larger scale.

One important point: a 401(h) is not a standalone account. You can't just open one at a brokerage firm the way you would an IRA. It must be attached to a qualified retirement plan — and that's where the real planning opportunity comes in.

A 401(h) account must be attached to one of two types of retirement plans: a money purchase plan or a defined benefit plan (which includes cash balance plans). The 401(h) rides along inside that "host" plan as a separate medical account.

Here's why this choice matters so much: the amount you can contribute to the 401(h) is limited relative to the contributions going into the host retirement plan. In plain terms, the medical account must stay subordinate — it's the sidecar, not the motorcycle. The bigger the retirement contributions to the host plan, the bigger the allowable medical contributions to the 401(h). This is where the two host plan options diverge dramatically.

A money purchase plan is a type of retirement plan where the business contributes a fixed percentage of compensation each year. It's simple and predictable, but contributions are capped at relatively modest levels — similar to what you'd see with a profit sharing plan.

Because the retirement contributions are smaller, the 401(h) contributions that can ride along with them are smaller too. A money purchase plan host can still be a fine choice in certain situations, but it puts a fairly low ceiling on your medical account funding.

A defined benefit plan works differently. Instead of contributing a percentage of pay, the plan promises a specific retirement benefit, and an actuary calculates how much must be contributed each year to fund that promise. For older, high-income business owners, those required contributions can be very large — often several times what a money purchase plan would allow. It's not unusual for a business owner in their fifties to contribute six figures annually to a defined benefit plan.

And because the 401(h) contribution limit scales with the host plan's contributions, a defined benefit host opens the door to much larger medical account funding. Instead of a modest annual medical contribution, you may be able to direct tens of thousands of dollars per year into the 401(h) — all deductible, all growing tax-free, all available tax-free for retirement medical costs.

The math is straightforward: larger host plan contributions mean larger 401(h) contributions. If maximizing the medical account is a priority, the defined benefit plan is almost always the stronger foundation.

The word "maximize" comes with guardrails. A few things to know:

• The subordination requirement. The medical account can never become the main event. Contributions to the 401(h) are limited to a fraction of the retirement contributions going into the host plan. Your plan's actuary and administrator will calculate the exact ceiling each year.

• Funding must be reasonable. Contributions to the 401(h) need to be based on a reasonable estimate of future retiree medical costs. You can't simply stuff the account with arbitrary amounts.

• Use it for medical, or lose the tax benefit. Money in a 401(h) is for qualified medical expenses. If funds are used for anything else, the favorable tax treatment disappears — so the account should be sized thoughtfully, not maximized blindly.

• Compliance matters. These plans involve actuarial calculations, annual filings, and careful documentation. This is not a do-it-yourself arrangement; you'll want an experienced third-party administrator and actuary in your corner.

If your goal is to maximize 401(h) contributions, the playbook looks like this:

• Choose a defined benefit plan as the host. It allows for much larger retirement contributions, which in turn support much larger medical account contributions.
• Fund the host plan generously. The 401(h) ceiling rises and falls with the retirement contributions, so a well-funded defined benefit plan is the engine that drives everything.
• Size the medical account realistically. Work with your administrator to estimate your actual retirement healthcare costs — premiums, out-of-pocket expenses, long-term care — and fund toward that number.
• Get professional design help. The difference between a mediocre 401(h) outcome and a great one usually comes down to plan design decisions made at the start.

Healthcare is likely to be one of the largest expenses you face in retirement. Most people will pay those bills with after-tax dollars. A properly structured 401(h) lets you pay them with money that was deducted on the way in, grew tax-free, and comes out tax-free — a combination that's hard to beat anywhere else in the tax code.

If you're a business owner with strong income and a long runway of contributions ahead of you, pairing a defined benefit plan with a 401(h) account may be one of the most powerful planning moves available. The key is getting the structure right from day one.