The Subordination Limit in a Money Purchase 401(h): How Much Can You Actually Fund?

A 401(h) plan is a special medical benefits account linked to a qualified pension or annuity plan. It allows for tax-deductible contributions to be made by an employer, which can then be used to pay for the medical expenses of retirees, their spouses, and dependents. These plans offer a unique way to save for healthcare costs in retirement, separate from general retirement savings.

Unlike Health Savings Accounts (HSAs) or Flexible Spending Accounts (FSAs), a 401(h) plan is typically established in conjunction with a defined benefit pension plan or, in some cases, a money purchase pension plan. This integration provides a powerful vehicle for business owners and high-income earners to pre-fund future medical expenses with significant tax advantages.

The subordination limit is a crucial rule for any 401(h) plan. It dictates that contributions to the 401(h) medical benefits account cannot exceed 25% of the employer contributions made to the related pension or annuity plan since the 401(h) was established. This isn't just an annual limit, but a cumulative one, looking at total contributions over the plan's lifetime.

This limit ensures that the 401(h) aspect of the plan remains

While traditionally associated with defined benefit plans, a 401(h) can also be paired with a money purchase plan. A money purchase plan is a type of defined contribution plan where employers contribute a fixed percentage of each employee's compensation annually. When combined with a 401(h), this offers a strategic approach to retirement and healthcare savings.

For business owners, especially those with no or few employees, combining a money purchase plan with a 401(h) can be particularly appealing. It allows for predictable, tax-deductible contributions to both retirement and future healthcare expenses, offering a potentially more robust benefit structure than a standalone 401(k) or other common plans.

Careful planning is essential to maximize your 401(h) contributions while adhering to the subordination limit. The key is to understand the interplay between your money purchase plan contributions and your desired 401(h) funding.

Consider the following strategies:

• Optimize Money Purchase Contributions: Since the 401(h) limit is based on your money purchase contributions, a higher base contribution to the pension plan allows for greater potential 401(h) funding. Consult with a financial advisor to determine the optimal contribution levels for your specific circumstances.
• Long-Term Projections: The subordination limit is cumulative. This means understanding your projected contributions over several years can help you strategically front-load or adjust contributions to maximize overall 401(h) funding without exceeding the limit.
• Regular Review: Plan regulations and your financial situation can change. Regularly reviewing your plan documents and contribution strategy with a qualified professional ensures continued compliance and optimization of your benefits.

While the 401(h) subordination limit is a critical consideration, it's part of a larger picture in comprehensive retirement planning. Integrating your 401(h) with other retirement vehicles, such as a defined benefit plan or a 401(k), can create a multi-faceted approach to securing your financial future.

For small business owners and high-income earners, the strategic use of plans like the 401(h) within a money purchase or defined benefit structure offers significant opportunities for tax-advantaged savings and wealth accumulation. Always seek personalized advice from tax and financial professionals to design a plan that aligns with your specific goals and circumstances.