401(h) Disadvantages: Here’s What They Don’t Tell You

By now you probably understand the main benefits of 401(h) accounts. You can read about all the advantages and benefits here. But what about the 401(h) disadvantages? There are a few of them that you should be aware of.

Advantages of a 401(h) Account

The advantages to 401h plans and very evident. They provide retiree health and medical benefits to retirees, spouses, and dependents. The main requirement is that the “plan” can only offer medical benefits. A 401(h) is not really a plan but an account that is tacked on to a pension plan under a separate plan document. 

The company is not required to make 401(h) contributions, even though a contribution could be made under the plan limits. The company can select to contribute any specified amount into the 401(h) account in a given year up to the maximum allowable contribution using a cumulative 25% limit.

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Disadvantages of a 401(h) Account

Individually & Custom Designed Plan Document. Health benefits under 401(h) accounts are not approved under Prototype, Master, or Volume Submitter plans supplied by many providers. As such, it requires a custom plan design. This typically means higher costs and few administrators in the market.

Plan Ambiguity. Based on the IRS regulations, it is very clear that 401(h) are legal and usable by employers. But the IRS has not issued many rules governing how the plan should be operated and established. As such, there is some ambiguity in the marketplace among plan administrators. There can be a variety of approaches and plan documents. In addition, many plan administrators have decided to stay away from the plans, resulting in few administrators offering the plans and less information in the marketplace.

Usage only upon retirement.  Funds can only be used for medical benefits when the participant retires. This is in contrast to Health Savings Plans (HSAs) that can be immediately accessed during employments and upon the contribution of funds into the account. As a result, 401(h) plans make more sense for employers with few employees and close to retirement age.

Fee structures. These plans can be a bit more expensive to administer compared to an HSA. In fact, they require a form 5500 to be filed annually. The higher fees are one disadvantage of the high contribution amounts.

Plan structures. Remember that 401h accounts can only be set up in conjunction with a defined benefit plan, cash balance plan or money purchase plan. You need to have a “pension” plan. You can’t pair the account with a 401k plan or a SEP. Most business owners simply don’t have the cash to be able to fund these accounts. Pension plan will require annual contributions and this simply won’t work for many business owners.


401h accounts can be great for medical expenses. But make sure you consider the cost and some of the headaches involved. While it’s true that you can get large tax-deductible contributions into the plan, it’s not going to be the best option for everybody.

In addition, there are not many plan administrators out there that set up 401h accounts. So make sure you do your due diligence and find a provider that works best for your situation. 

But don’t think that tax-free medical benefits don’t come without some pitfalls. There are definitely some things you should consider before you set up a 401h account.

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