Defined Benefit Plans — How They Work and Where 401(h) Fits

The core idea

A defined benefit (DB) plan promises participants a specific retirement benefit, typically calculated by a formula based on compensation and years of service. The employer is responsible for funding the promised benefit; contributions are calculated each year by an enrolled actuary. That makes DB plans fundamentally different from defined contribution plans like the 401(k), where the employee's account is the benefit and there is no promised payout.

DB plans vs cash balance plans

A cash balance plan is a defined benefit plan that expresses the benefit as a hypothetical individual account that grows with annual pay credits and an interest credit. Legally it is still a DB plan, so it can host a 401(h) sub-account when drafted to do so. Cash balance plans are popular with owner-led businesses because the account-style presentation is easier for participants to understand than a classic monthly-benefit formula.

• Traditional DB: formula such as 1% × final-average pay × years of service.
• Cash balance: annual pay credit (e.g. 5–25% of compensation) plus an interest credit.
• Both: employer funded, actuarially determined, PBGC-covered when applicable.

Why owner-led businesses look at DB plans

For a profitable business with stable cash flow, a defined benefit or cash balance plan can allow contributions far above 401(k) and profit-sharing limits — often six figures per year for older owners. That makes the DB chassis a natural starting point if the business is also considering a 401(h) retiree medical sub-account, because the qualified plan infrastructure already exists.

Where 401(h) fits inside a DB plan

A 401(h) account is a separate sub-account, authorized by IRC §401(h), that can be added inside a qualified pension plan to pay sickness, accident, hospitalization, and medical expenses for retired employees, their spouses, and dependents. It is not a substitute for a 401(k), HSA, HRA, or VEBA — it is an additional, internally tracked account that lives inside the same qualified trust as the retirement benefit.

• The plan document must specifically authorize the 401(h) sub-account.
• Assets must be separately accounted for, even if invested together.
• Medical benefits must remain incidental — subordinate — to retirement benefits.
• Key-employee benefits have additional separate-account requirements.

Funding and administration

DB and cash balance plans require an annual actuarial valuation, a written funding policy, ongoing plan administration, and an annual Form 5500 filing. When a 401(h) account is added, the valuation also addresses the incidental-benefit constraint and tracks separate-account balances. None of this is do-it-yourself: it requires a coordinated team of plan professionals, an enrolled actuary, ERISA counsel, and a tax advisor.

Who DB + 401(h) typically fits

The combination tends to be evaluated by profitable, stable, owner-led businesses with a small group of long-tenured employees, predictable cash flow, and an interest in formalizing and pre-funding a portion of retiree medical costs. Suitability is always fact-specific, and the strategy should be reviewed end-to-end before any plan document is adopted.