401(h) accounts are one of the best kept secrets in the medical deduction space. But the problem is that there really is not a lot of information on the specifics of the plans.
We know that 401h accounts can be difficult to understand. In this post, we will address the 401h account FAQs.
A 401(h) is not a separate plan but more of a medical benefit add on to defined benefit plans and other pensions. Contributions to the 401(h) account give you three main benefits:
1) They are are tax-deductible;
2) Earnings in the account will grow tax-free;
3) Medical benefits paid are not taxable to retirees as long as they are qualified expenses.
The account itself is somewhat like a Health Savings Account (HSA) but it has higher limits. However, there are certain limitations and restrictions that can make it challenging for a company to implement a plan.
A 401(h) account can only best established in conjunction with a qualified pension plan. These qualified plans include defined benefit plans, cash balance plans and money purchase plans.
According to the Treasury Regulations (§ 1.401-14(c)), a 401(h) account is required to provide for the following:
1) Medical benefits are required to be “subordinate” to the actual pension benefits;
2) Medical benefits must be maintained in a separate account within the pension trust;
3) For any key employee, another separate account is required to be maintained for the benefits paid to that employee;
4) Employer contributions are required to be reasonable and ascertainable;
5) All contributions (within the taxable year or after that) to the 401(h) account must be used to pay medical benefits under the plan;
6) The plan’s terms must provide that, upon the satisfaction of all liabilities for the retiree medical expenses, all amounts remaining in the 401(h) account must be returned to the employer.
Since a 401h account is essentially “tacked on” to a defined benefit plan or cash balance plan, it will use the same trust that the defined benefit plan utilizes. But it is required to have a separate bank account to track the contributions and distributions from the account.
Yes. The contributions are tax deductible and the distributions for qualified medical expenses are a reduction of the plan assets.
In addition, 401(h) account earnings on balances remain tax-deferred and distributions are tax-free when used for qualified health care expenses.
This can be more difficult than you might have thought. It can be quite challenging to locate a third party administrator that can draft a plan document. This is because 401(h) account plans are not approved under Master and Prototype or Volume Submitter plans.
As a result, custom plan documents are required and many people just don’t operate in the space.
Yes you can. A cash balance plan is a type of defined benefit plan. As such, you can add a 401(h) component to such a plan.
Yes. A money purchase plan is actually a type of defined contribution plan. However, it falls under the “pension” definition because it can required minimum contributions. As a result, you can add a 401(h) account provision to a money purchase plan.
Business owners are not required to make annual 401(h) contributions even when allowable. As such, a company could choose to contribute any amount for a given year up to the maximum 25% cumulative limit.
There is no specified dollar limit. But the contributions to the account cannot exceed 25% of the total contributions to the pension plan, excluding contributions made for prior service. This limitation is set forth after the date the 401(h) account was actually established.
However, the 25% limit is a cumulative limit based on all employer contributions to the pension after the 401(h) account was set up. Accordingly, if a company makes 401(h) contributions for a few years that are lower than the maximum amount allowed under the 25% restriction, the employer can make additional (or “catch up”) 401(h) contributions to get to the cumulative 25% limit. This is the case even though it might not be allowed to make contributions to the retirement component of the plan.
401(h) contributions are not subject to the normal vesting requirements like pension plan contributions.
Ongoing plan administration requirements are typically not that challenging but need to be considered. A Form 5500, Form 5500-SF, or Form 5500-EZ must be filed each year.
There are some software packages available to small businesses that enable the business owner to handle the filings on their own. Otherwise, qualified plan administrators and CPAs should be outsourced to submit the filings and ensure they are taken accurately.
Typical medical expenses that can be reimbursed include health insurance premiums, deductibles, physician fees, prescription costs, dental care fees, vision care fees, chiropractor fees, psychiatric care fees, hospital bills, laboratory fees, orthodontics costs, and medical supplies costs. Also included are acupuncture, capital expenses to modify the home for a disability, hearing aids, laboratory fees, nursing home and services, smoking cessation programs, substance abuse treatment, therapy, transplants, wheelchairs, and X-rays.
Expenses that are not reimbursable include babysitting services for a healthy child, controlled substances that are not legal under federal law, cosmetic surgery that does not treat a disease or correct a disfigurement, dancing or swimming lessons, diaper services, electrolysis or hair removal, funeral expenses, future medical care, hair transplants, health club dues, household help, medicines or drugs that were imported from other countries, nonprescription drugs and medicines, nutritional supplements, personal use items (such as toothbrush and toothpaste), teeth whitening, veterinary fees, or weight-loss programs.