What is a 401(h) Account? A Plain-English Guide for Business Owners [2026]

Let's start by correcting one thing. There is no such thing as a 401(h) plan. A 401(h) is an account — a separate medical account added inside a qualified pension plan the employer already sponsors. You cannot buy one, open one, or roll anything into one. It exists only as a feature of a retirement plan that has been drafted to include it.

That distinction is critical. Almost every misunderstanding about 401(h) traces back to people picturing a standalone product. Once you see it correctly — as a compartment built into a pension plan — the rules, the limits, and the risks all start to make sense.

People say "401(h) plan" the way they say "401(k) plan," and the two phrases sound like they describe the same kind of thing. They don't.

A 401(k) is a plan. It is the whole structure: a document, a trust, participants, contributions, an account for each person. You can sponsor one on its own.

A 401(h) is a sub-account. It has to live inside something else — almost always a defined benefit or cash balance pension plan, occasionally a money purchase or other qualified annuity plan. There is no 401(h) application form, no custodian who offers one, no minimum deposit. The plan document, the actuarial work, the trust, the recordkeeping, and the annual compliance all belong to the underlying pension plan. The medical account is one section of that plan's paperwork and one line in its accounting.

The practical version. If you don't already have a pension plan — or you aren't willing to start one and fund it every year — you don't have a 401(h) conversation. You have a pension plan conversation first. The medical account is a decision you make after that, not instead of it.

A 401(h) account is a separately tracked medical account inside a qualified pension plan. The employer funds it. The money grows inside the plan's trust without current tax. Later, it pays or reimburses certain medical expenses for retired employees, their spouses, and their dependents.

Three things make it interesting:

• The employer generally deducts the contribution when it goes in.
• The money accumulates inside the trust without being taxed along the way.
• Benefits paid to a retiree for qualifying medical costs are generally tax-free to the person receiving them.

Very few structures in the tax code do all three. That's the appeal. The rest of this article is about what it costs you to get there — because the limits and the restrictions are severe enough that most people who ask about a 401(h) end up not using one.

The rules require the medical portion to be tracked apart from the retirement portion. That does not mean a separate bank account or a separate trust. The assets can sit in the same trust and be invested together. What has to be separate is the accounting: contributions made for medical benefits are designated as such when they go in, and the assets attributable to the medical account are tracked on their own from that point forward.

There's a second layer for owners and other key employees. Their medical benefits have to be tracked in an individual account within the medical account, and the benefits available to them are limited to what's actually in their own account. That detail matters more than it sounds — it's the reason the owner's number is capped independently of everything else. More on that below.

This is the point most articles get wrong, so it's worth being blunt: a 401(h) account pays benefits for retired employees, their spouses, and their dependents. It is retiree medical funding. It is not a way to pay the medical bills of your active workforce, and it is not a way to pay your own medical bills while you're still running the business.

The plan document defines who counts as retired and what the plan will pay for. The categories of expense generally track the same kinds of medical costs that qualify for the itemized medical expense deduction — doctors, hospitals, prescriptions, and depending on how the plan is written, insurance premiums including certain Medicare and long-term care costs. What your plan actually covers is a drafting question, not a given.

Employer contributions do nearly all the work. Employee contributions are permitted in some designs but are after-tax and rarely used in owner-led businesses. Investment earnings on the account belong to the account and are not taxed as they accumulate.

The size of the annual contribution isn't discretionary the way a profit sharing contribution is. The plan has to specify the medical benefits precisely enough that an actuary can put a value on them, and the funding is generally spread on a level basis over participants' remaining working years. You are pre-funding a defined promise, not making a deposit into a savings vehicle.

This is where most 401(h) conversations actually get resolved. Three separate limits apply at the same time, and the lowest one wins.

Ceiling one — the medical account has to stay subordinate: the 25% test. Contributions to the medical account, added up from the day the account is created, cannot exceed 25% of total contributions to the plan over that same period. Contributions that fund credit for service before the plan existed are left out of the base. In practice: for roughly every three dollars going in for retirement benefits, at most about one dollar can go in for medical benefits. This is a cumulative test, not an annual one, which means a plan can drift out of compliance years after everyone stopped thinking about it.

Ceiling two — for owners, the medical contribution competes with the 401(k), and usually loses. For a key employee, which includes owners and certain highly paid officers, contributions to the medical account count against the same overall annual limit that caps everything going into that person's defined contribution accounts. For 2026 that ceiling is $72,000.

Read that again, because it is the single most overlooked fact about 401(h) accounts. A $20,000 medical contribution for the owner doesn't come out of thin air. It leaves $52,000 of room for that owner's 401(k) deferrals, employer match, and profit sharing combined. You are not adding a new bucket. For owners, you are dividing an existing one. This is why the strategy tends to work best where the owner is not already maxing out the defined contribution side — and why it often falls apart on the whiteboard for owners who are.

Ceiling three — the actuary's number. Even if the first two tests leave room, you can only fund the benefit the plan actually promises, valued on reasonable assumptions. You cannot decide you'd like to contribute more this year because it was a good year. The promised benefit drives the contribution, not the other way around.

The reason anyone reads this far is the tax result. Assuming the account is properly established and funded within the limits:

• Employer contribution — generally deductible by the business in the year contributed, within the funding limits.
• Growth inside the trust — accumulates without current income tax.
• Benefits paid to a retiree — generally not taxable to the retiree, spouse, or dependent when used for qualifying medical costs.

The condition attached to that third item is the one that ends a lot of owner-only cases: the tax-free treatment on the receiving end depends on the recipient being treated as an employee for health benefit purposes. Which brings us to the question that should be asked first, not last.

Retirement plan rules and health benefit rules define "employee" differently, and 401(h) sits on top of both.

• C corporation. An owner who works in the business is an employee for both sets of rules. This is the clean case, and it's where 401(h) has the longest track record.
• S corporation, more-than-2% shareholder. For health benefit purposes, these owners are generally treated like partners rather than employees — which puts the tax-free reimbursement in question for that person, even though the same individual is unquestionably an employee for pension purposes.
• Sole proprietor or partner. Same problem, more directly. Self-employed individuals are treated as employees for retirement plan purposes but not for health benefit exclusion purposes.

We're going to be candid here in a way that most articles aren't: parts of this are unsettled. The IRS has not issued clear, published guidance resolving how the medical account rules apply to S corporation owners and self-employed individuals, and the analysis relies on reading two sets of rules together that were not written with each other in mind. Anyone who tells you this is a solved question for a pass-through owner is telling you more than the guidance supports.

If you are a pass-through owner and the 401(h) benefit is meant primarily for you, this belongs in front of ERISA counsel before the plan document is drafted — not after.

The tax profile is genuinely attractive. The trade-offs are real, and they're the reason 401(h) accounts remain relatively uncommon in small plans.

The money can't come back out for anything else. Once contributed, the account can only be used for retiree medical benefits until all of those obligations are satisfied. It is not available for retirement benefits, not available to the business, and not available to the owner for any other purpose.

Leftover money is expensive. If obligations are satisfied and money remains, it returns to the employer — as taxable income, plus an excise tax that can reach 50%. Overfunding a 401(h) account is not a harmless mistake. It is the most costly way to be wrong in this structure.

You probably can't cover only yourself. Medical benefits are subject to nondiscrimination rules. In a business with rank-and-file employees, promising retiree medical benefits to the owner generally means promising them more broadly. That's a long-term liability, not a one-year cost.

It's a promise, not a contribution. Retiree medical is a benefit obligation the plan takes on. Unwinding it later is harder than stopping a discretionary contribution, and it has to be handled through plan amendment and termination rules.

The administrative load is permanent. Specific plan language, separate accounting, individual tracking for owners and key employees, actuarial valuation of the medical benefit, annual reporting, and substantiation of claims — every year the account exists.

Nothing is portable. Unlike a health savings account, there is no participant-owned balance to take with you. There's a promise from a plan, subject to that plan's terms.

There's a version of this that works differently and deserves its own mention.

If a defined benefit plan is significantly overfunded, the sponsor faces an unpleasant problem: pulling surplus assets back out triggers income tax plus a punitive excise tax. The rules permit a sponsor that meets a funding threshold to instead transfer a portion of that surplus into a medical account within the same plan, to pay current retiree health costs — without treating the move as a reversion. It's often called a surplus transfer, and the authority for it runs through the end of 2032.

Two notes on the current state of play. The threshold for smaller transfers was relaxed by recent retirement legislation, which widened the group of plans that can use it. And in 2026, the IRS added these transfers to its list of issues on which it will not issue advance private rulings — so sponsors who previously would have sought comfort from the IRS before acting no longer have that option and are relying on their own analysis instead.

For a sponsor sitting on a materially overfunded plan with real retiree health costs, this is often the most practical use of a 401(h) account in the market today. It is a different problem than "how do I get another deduction," and it has a different answer.

Nothing about the underlying rules is new. What changed is how many businesses have the prerequisite.

Cash balance and defined benefit plans have become mainstream for owner-led businesses that want to save well beyond what a 401(k) allows. Once that plan exists, the medical account becomes a live question rather than a theoretical one — which is why advisors are raising it more often. Add rising retiree healthcare costs and a decade of pension plans that are now well funded, and the topic surfaces on its own.

The interest is structural. More owners simply have the underlying plan that a 401(h) account requires.

Worth exploring if:

• You already sponsor a defined benefit or cash balance plan
• Your plan is overfunded and you're facing a reversion problem
• You're taxed as a C corporation
• You intend to support a defined group of retirees and are comfortable committing to it
• Cash flow is stable and predictable enough to fund the promise
• You accept ongoing actuarial and compliance work

Probably not a fit if:

• You have no qualified pension plan and don't want one
• You're already using the full defined contribution limit for yourself
• You're a sole proprietor or pass-through owner looking to cover only yourself
• You want flexibility to change your mind year to year
• You're looking for a one-time deduction
• You want a product you can open and manage yourself

For the businesses where it fits, the structure is unusually efficient — a deduction going in, untaxed growth in the middle, and tax-free benefits coming out for people who will face real medical costs in retirement. Very little in the tax code does all three.

But the fit is narrower than the marketing around this topic suggests. The 25% test limits how much you can put in. The annual additions ceiling means an owner's medical contribution comes out of the same pool as their 401(k) and profit sharing. Nondiscrimination rules mean you likely can't cover yourself alone.

The money, once in, can only be used for one thing — with a costly penalty on anything left over. Those constraints don't disqualify the strategy. They just mean it works for a specific kind of employer rather than for everyone with a good tax year.

If you already sponsor a defined benefit or cash balance plan, if your plan is overfunded and reversion is on the table, or if you're a C corporation owner who hasn't yet used up your defined contribution room, this is worth an hour of real analysis with your actuary and tax advisor.