401(h) Plans

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.

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 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.

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Sample List 401(h) 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.

Acupuncture	Hospitalization Insurance
ADD Counseling and Assistance	Hospital Bills
Air Lift Transportation	Insulin
Alcoholism	Laboratory Fees
Alternative Healthcare	Laetrile by Prescription
Alternative Medicines	Lasik Eye Surgery
Ambulance	Hire Lead Base Paid Removal-Children
Artificial Limbs	with Lead Poisoning
Artificial Teeth	Retirement Home for Medical Care
Assisted Living Facilities	Long Term Care, Nursing Homes
Asthma and Allergy Treatment	Medical Information Plan
Birth Control Pills	Medicines
Braces	Membership Fees for Medical Services,
Braille-Books and Magazines	Hospitalization, Clinical Care, Health
Chiropractors	Maintenance, Health club memberships
Christian Science Practitioners’ Fees	Nurses’ Fees, Nurses’ Room and Board
Contact Lenses Including Exam Fee	S.S. Tax (Where Paid by Taxpayer)
Co-Pays	Obstetrical Expenses
Cosmetic Surgery (Even Though not	Operations (100% of All Costs)
by a Physician)	Orthopedic Shoes
Cost for Care Outside the United States	Oxygen
Cost of Operations & Related Treatments	Personal Trainers
Counseling	Physical Therapy
Crutches	Physician Fees
Deductibles	Premiums for LTC
Dental Cosmetic Surgery	Preventive Care including but not limited to
Dental Fees	Spa Facilities, Usage Fees for Facilities
Dentures	Prosthetics
Dependent Care	Psychiatric Care
Dermatologist Care	Psychologist Fees
Diagnostic Fees	“Seeing-eye” Dog and its Upkeep
Drugs	Specialists and Specialized Treatments
Electrolysis	Specially Equipped Cars
Experimental Care	Special Care Costs for Disabled Dependents
Eyeglasses, Including Examination Fee,	Special Diets
Laser Surgery for Vision Correction	Sterilization Fees
Fees of Practical Nurse	Support Groups
Fees for Healing Services	Surgical Fees
Fees of Chiropractors	Therapy Treatments
Fees for Fitness Programs and Facilities	Transport Expenses for Medical Services
Fees of Licensed Osteopaths	including Preventative Care
Flu Shots	Tuition at Special School for Handicapped
Hair Transplants	Viagra
Health Insurance Premiums	Vitamins
Hearing Devices and Batteries	Wheelchair
Hospice	Weight Loss Programs
In-Home Care	X-rays