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401(h) Plans

Tax-Deductible, Tax-Sheltered, and Tax-Free Payouts

What is a 401(h) plan? It’s a medical expense account under Code Section 401(h). The plan pays for costs associated with sickness, accident, hospitalization, and medical expenses of retired employees (EEs) (and their spouses and dependents).

One of the largest expenses of retirees is their health-care costs. How do retirees pay for such costs? Typically, with savings or out of their taxable income.

With a 401(h) plan, an employer can take a 100% deduction to fund a tax-free sinking fund where when retired EEs remove money from the plan to pay for medical expenses, there are NO income taxes due.

Post-Retirement Medical Benefits

The 401(h) post-retirement medical option is perhaps the most overlooked and underutilized plan benefit in the industry today. The 401(h) benefit can add up to 33.33% to the otherwise maximum tax-deductible contribution of your pension plan.

Is a 401(h) plan practical and should you use one? If you are a profitable small business owner, the answer is absolutely. Let me show you an example.

Example: Assume Mr. Smith (business owner) earns $400,000 a year (W-2) and has five employees of various ages and salaries. Mr. Smith has been funding in a tax-deferred manner $80,000 into a defined benefit plan every year. If he keeps doing this, he will ultimately have approximately $2,000,000 in the plan when he turns 65 years old. Assume that on average Mr. Smith will have $10,000 of medical expenses every year in retirement. Assume he is now and will be in the 35% income tax bracket.

How can a 401(h) plan help?

Mr. Smith could have his business fund X amount of money in a tax-deductible manner into a 401(h) plan every year as an employee benefit for himself and the other employees (discrimination testing for EE contributions is done using the classic age, years of service, and salary testing guidelines).

The money is allowed to grow tax-free and can then come out tax-free from the 401(h) plan if used for medical expenses (including elective surgery). Therefore, instead of funding $80,000 every year into a defined benefit plan, let’s assume he allocates $10,000 of the $80,000 to the 401(h) plan from ages 55-65.

At age 65, what is the net positive benefit of using the plan?

If we assumed a 5% rate of return in the 401(h) plan and the pension plan, the accounts would both have the same balances when Mr. Smith hits age 65: $149,171 (we are just comparing the $10,000 contribution made from ages 55-65).

Now let’s assume that Mr. Smith incurs $10,000 of medical expenses every year in retirement. When Mr. Smith uses $10,000 from his 401(h) plan, the money comes out 100% tax-free. When he removes it from the defined benefit plan to pay expenses, it is 100% taxable.

How do the numbers compare?

From the 401(h) plan, he could remove $10,000 a year tax-free until he turns age 90.

However, because he would have to remove $15,384 from his taxable pension plan to net $10,000 after-tax, he would run out of money in this example at age 78.

Therefore, the net positive benefit to Mr. Smith when allocating $10,000 to a 401(h) plan vs. a tax-deferred plan is $127,007. This is how much more after-tax money could be removed over time using the 401(h) plan in my example.

As I stated earlier, virtually no one is aware of 401(h) plans and their tremendous post-retirement medical benefits.  If you like the idea of tax deducting money into a plan where it is allowed to grow tax-free and be removed tax-free in retirement, then you need to implement a 401(h) plan.

Getting help/More information

If you would like more information or help to implement a 401(h) plan in your business, please contact our office at admin@aspencreekfinancial.com or 888-937-1937.

Sample List of 401(h) Post-Retirement Medical Benefits

Below is a sample list of post-retirement medical benefits that may be provided under a Benefits are not limited to those contained in this list.

AcupunctureHospitalization Insurance
ADD Counseling and AssistanceHospital Bills
Air Lift TransportationInsulin
AlcoholismLaboratory Fees
Alternative HealthcareLaetrile by Prescription
Alternative MedicinesLasik Eye Surgery
AmbulanceHire Lead Base Paid Removal-Children
Artificial Limbswith Lead Poisoning
Artificial TeethRetirement Home for Medical Care
Assisted Living FacilitiesLong Term Care, Nursing Homes
Asthma and Allergy TreatmentMedical Information Plan
Birth Control PillsMedicines
BracesMembership Fees for Medical Services,
Braille-Books and MagazinesHospitalization, Clinical Care, Health
ChiropractorsMaintenance, Health club memberships
Christian Science Practioners’ FeesNurses Fees, Nurses Room and Board
Contact Lenses Including Exam FeeS.S. Tax (Where Paid by Taxpayer)
Co-PaysObstetrical Expenses
Cosmetic Surgery (Even Though notOperations (100% of All Costs)
  by a Physician)Orthopedic Shoes
Cost for Care Outside the United StatesOxygen
Cost of Operations & Related TreatmentsPersonal Trainers
CounselingPhysical Therapy
CrutchesPhysician Fees
DeductiblesPremiums for LTC
Dental Cosmetic SurgeryPreventive Care including but not limited to
Dental FeesSpa Facilities, Usage Fees for Facilities
DenturesProsthetics
Dependent CarePsychiatric Care
Dermatologist CarePsychologist Fees
Diagnostic Fees“Seeing-eye” Dog and its Upkeep
DrugsSpecialists and Specialized Treatments
ElectrolysisSpecially Equipped Cars
Experimental CareSpecial Care Costs for Disabled Dependents
Eyeglasses, Including Examination Fee,Special Diets
Laser Surgery for Vision CorrectionSterilization Fees
Fees of Practical NurseSupport Groups
Fees for Healing ServicesSurgical Fees
Fees of ChiropractorsTherapy Treatments
Fees for Fitness Programs and FacilitiesTransport Expenses for Medical Services
Fees of Licensed Osteopathsincluding Preventative Care
Flu ShotsTuition at Special School for Handicapped
Hair TransplantsViagra
Health Insurance PremiumsVitamins
Hearing Devices and BatteriesWheelchair
HospiceWeight Loss Programs
In-Home CareX-rays

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