Many people are unaware of 401(h) plans, but these plans can provide great tax free benefits during retirement. If a retired employee will be spending a lot of money to cover medical expenses during retirement, this is the plan to look into.
What is a 401(h) plan?
There are thousands of people who have never even heard of a 401(h), so we will first explain what this is and how individuals can benefit from using this tool. The 401(h) plan is a retirement plan that was considered to be a medical expense account. The plan would reimburse for any expenses that were related to hospitalization, accidents or illness for retired employees (EEs). The plan would also pay for the medical expenses of dependents (as children) and spouses.
Since health care costs are always going up and are one of the greatest costs for any retired employee, people wonder how retired people can pay for medical expenses. In many cases, the costs will be covered by out of pocket payments made by the retiree.
If a 401(h) plan is being used, an employer will be able to deduct 100% of their 401(h) contributions to fund the plan that will allow retired EEs to take out the money from the plan when needed. This money would be used to cover medical costs and one of the primary tax benefits is that no income taxes would be owed as a result.
How good is the 401(h) plan in retirement planning?
These plans are in fact extremely practical and advisors should recommend them.
Example: We will assume that Dr. Vish has a practice with four employees that earn different incomes. The employees are also different ages. The dentist earns $350,000 annually and has been contributing to a defined benefit plan annually with $75,000. If the dentist continues with the defined benefit plan, he will have around $1.6M in the plan at the age of 63. We will presume that the dentist will incur $8,000 of medical costs annually after he retires. In addition, he will remain in the 35% tax bracket.
401(h) Plans Benefits
The dentist has the option of funding money that is tax deductible into a 401(h) plan as an employee benefit. This would apply to his employees as well as himself. Remember that discrimination testing for Employee Earnings consists of evaluating the years of labor, income and the ages of the employees.
The money that is placed into the 401(h) plan would accumulate tax free and can later be removed tax free from the plan if the money is to be used to cover medical fees. This can include costs of elective surgeries. The 401(h) plan benefits because instead of contributing $75,000 into a defined benefit plan, the dentist will instead contribute $8,000 of that amount to the 401(h) plan.
The Net Result of the 401(h) Plan at 65 Years Old
If the 401(h) has a 5% return and the pension plan also has the same rate of return, each plans would have the same balance when the dentist reaches 63. The amount would be $126,288, based on a $8,000 fund each year between the 53 years old and 63.
We will also presume that the dentist incurs $10,000 of annual medical costs when he retires. When this amount is used from the 401(h) retirement plan, the money will not be taxed when it is removed. However, if that same amount were to be removed from a defined benefit plan, it would be taxed around 35-40%.
401(h) Plan vs Defined Benefit Plan
It would be possible for the dentist to take $8,000 from the 401(h) plan each year until he is 90 years of age and not pay any taxes.
If the dentist needed the same amount from the pension plan, he would have to withdraw $13,121 to cover the taxes that he would incur. In this case, by the time he reached 76, he would likely be out of money.
The result is that the net benefit when contributing $8,000 to the 401(h) plan would be $103,876. $103,876 is the amount that could be removed tax free from the 401(h) plan over a period of time over and above what could be taken from a defined benefit plan in a comparison study.
When looking to save money in retirement and have a means to cover medical costs, a 401(h) plan is the best way to go. As people age, medical expenses will increase. Having this type of plan will provide many benefits and will help individuals pay their medical expenses without incurring taxes.
Below is a sample list of post-retirement medical benefits that may be provided under a Benefits plan but 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 |
| 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 Practioners’ 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 by a Physician) |
| Operations (100% of All Costs) | 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 |
Contact Estate Street Partners to discuss how we can help you plan for retirement using the 401(h) plan or any other retirement strategy.