What a §401(h) account is
A §401(h) account is a separate sub-account inside a defined benefit pension plan that pays for retiree (and dependent) medical expenses. Employer contributions to the §401(h) account are tax-deductible, the assets grow tax-deferred, and qualified medical-expense distributions to retirees are tax-free.
How it attaches to a DB plan
- The §401(h) account must be part of an existing qualified DB plan (cash balance or traditional DB).
- It is administered as a sub-account, with separate accounting from pension assets.
- Benefits are paid only after the participant has retired and incurred eligible medical expenses.
- Investment policy is typically aligned with the underlying DB plan.
The 25% subordination rule
IRC §401(h)(1) requires that medical benefits be subordinate to retirement benefits. In practice, the IRS interprets "subordinate" to mean cumulative §401(h) contributions cannot exceed 25% of cumulative aggregate contributions to the DB plan (including the §401(h) account itself).
Qualified medical expenses
- Medicare premiums (Part B, Part D, Medicare Advantage).
- Long-term care insurance premiums (within IRC age-based limits).
- Medical, dental, vision, and prescription expenses for the retiree, spouse, and dependents.
- Out-of-pocket Medicare cost-sharing (deductibles, copays, coinsurance).
vs. an HSA in retirement
| Dimension | HSA | §401(h) account |
|---|---|---|
| Annual contribution limit (2025, family) | $8,550 (+ $1,000 catch-up at 55) | Up to 25% of DB cumulative — often $50–100K+ |
| Who funds | Employee or employer | Employer (business deduction) |
| Medicare enrollment effect | Ends contributions | No effect |
| Use for non-medical after 65 | Allowed (taxable) | Not allowed |
| Non-spouse heir treatment | Fully taxable at death | Reverts to plan / forfeit if no eligible beneficiary |
Where it fits and where it doesn't
Where it fits
- Practices already operating a cash balance plan with consistent contributions.
- Owners projecting significant retiree medical and Medicare expenses.
- Households where the HSA is already maxed and additional medical-tax-shelter capacity is wanted.
Where it does not fit
- Businesses without a defined benefit plan in place.
- Owners planning to retire in a low-medical-expense scenario where the contribution would never be used.
- Highly variable income — the §401(h) is administratively layered on top of an already-mandatory DB contribution.
For the right candidate the §401(h) is one of the cleanest medical-tax-shelter tools available — but it is always an enhancement to an existing DB plan, never a stand-alone product.
Stephen Arnold
Founder & CEO of Wealth Protection Advisory. Pension and retirement planner with 20+ years advising small business owners. Creator of the Designer DB Plus® strategy and author of Designer DB Plus® Game-Changing Tax Reduction & Retirement Strategy.