Sizing the §401(h) contribution requires balancing three constraints: the 25% subordination cap, projected lifetime retiree medical spend, and the sponsor's desired annual tax deduction.
Step 1 — Project retiree medical lifetime spend
Estimate total retiree medical lifetime cost per covered family — typically $400,000–$800,000 for a 65-year-old couple including Medicare premiums, LTC, and out-of-pocket. This is the target that §401(h) capacity should be sized to over the funding window.
Step 2 — Calculate annual subordination capacity
Take the annual DB contribution and target a §401(h) contribution equal to 18–22% of the combined annual contribution. This stays comfortably under the 25% cumulative cap with room for actuarial smoothing.
Step 3 — Solve for years to fully fund
Divide projected lifetime spend by annual §401(h) capacity to see how many years of funding are needed. For a 50-year-old owner with $75,000/year of capacity and a $600,000 lifetime target, fully funding takes roughly 8 years of contributions plus growth.
Step 4 — Coordinate with the actuary
Final sizing is set by the plan's enrolled actuary, who confirms the contribution against the subordination test and the underlying DB plan's funded status.