IRS extends 401(h) medical benefits to in-service-eligible workers

Employers with surplus assets in a 401(h) account can use the money to pay medical benefits for active employees 59½ or older who are eligible for in-service pension distributions. The IRS set that out in Revenue Ruling 2026-22, released Oct. 28.

A 401(h) account lets an employer fund retired employees' medical expenses through a defined benefit or money purchase pension plan, if certain conditions are met, according to Groom Law's Oct. 30 Benefits Brief. An employee who is still working does not qualify as retired if separation from employment is a condition of receiving retirement benefits. In the ruling's fact pattern, the employer amended the plan so surplus 401(h) assets could pay active medical benefits for in-service-eligible employees and their dependents. Because separation was no longer a condition, the IRS ruled those employees met the definition of retired.

For advisers to defined benefit and money purchase plan sponsors, the ruling opens a route to spend surplus 401(h) money on active medical benefits for employees still on payroll. A sponsor no longer needs its own letter ruling, provided its plan facts are substantially the same as the fact pattern the ruling describes. The route runs through a plan amendment, and the employees covered will likely depend on the plan's own in-service distribution terms.

The IRS approved the design in eight private letter rulings beginning in 2023, but only the employer that requested a letter ruling can rely on it. Beginning in 2020, the age for in-service pension distributions decreased to 59½, which Groom says opened the door for employers to use some of their surplus 401(h) assets for medical benefits for active employees eligible for in-service distributions. Many employers have found their 401(h) accounts significantly overfunded, with few options for using the excess, according to the brief. Groom writes that "the Ruling provides the first guidance on which all employers can rely."

The ruling reaches only taxpayers whose facts are substantially the same as the fact pattern it describes. A plan design that differs materially would likely need its own letter ruling, which again would bind only the employer that requested it.