Paying 401(h) retiree medical benefits to age-59½ in-service participants does not disqualify the pension plan

Plain-English summary

An employer runs a defined benefit pension plan that also has a section 401(h) account, a separate sub-account inside the pension plan used to pay retiree medical benefits. The plan was amended, as section 401(a)(36) allows, to let participants who reach age 59½ start collecting pension payments even though they have not yet left their jobs. The employer then amended the plan again to let those same still-working, age-59½ participants have their health benefits paid from the 401(h) account. The employer asked the IRS whether paying 401(h) medical benefits to workers who have not separated from service would break the section 401(h) rules (which limit those benefits to "retired" employees) and jeopardize the plan's tax-qualified status. The IRS said no. Under the governing regulation, an employee counts as "retired" for 401(h) purposes if he is eligible to receive retirement benefits under the plan, and someone is excluded only when a separation from employment is a condition of getting those benefits. Because these age-59½ participants can draw their pension without separating, separation is not a condition, so they qualify as "retired employees." The IRS ruled the medical payments do not violate section 401(h) or Treas. Reg. § 1.401-14 and do not cost the plan its qualification under section 401(a). The IRS expressly gave no opinion on the income tax consequences to the employer of using the account this way.

Ruling snapshot

• Question: Does paying 401(h) retiree medical benefits to age-59½ participants who are still employed (and eligible for in-service pension distributions under section 401(a)(36)) violate section 401(h) or disqualify the plan under section 401(a)?
• Outcome: approved (no violation; plan retains qualified status)
• Key authorities: IRC §§ 401(a), 401(a)(36), 401(h), 420, 501(a); Treas. Reg. § 1.401-14(a), (b)(1)

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 202305001 Third Party Communication: None
Release Date: 2/3/2023 Date of Communication: Not Applicable
Index Number: 401.00-00, 401.27-00
Person To Contact:
---------------------------- ----------------, ID No. -----------------
------------------------------------------------------------ Telephone Number:
-------------------------------------------- ---------------------
------------------------------- Refer Reply To:
----------------------------- CC:EEE:EB:QP3
--------------------------- PLR-100612-22
Date:
November 04, 2022

Taxpayer = -------------------------------
Retirement Plan A = -------------------------
Post-Employment Health = ----------------------------------------------------------------------------
Benefit Plan
Health and Welfare Plan = ----------------------------------------------------------
Date 1 = --------------------------
Date 2 = -------------------------
Date 3 = -----------------------
Year 1 = -------
Year 2 = -------

Dear -------------------:

This is in response to your letter dated December 21, 2021, as supplemented by
information dated May 27, 2022, submitted on your behalf by your authorized
representative, in which you request rulings on the continued qualified status under
sections 401(a) and 401(h) of the Internal Revenue Code of a pension plan that is
amended to expand employee eligibility for benefits under the plan's section 401(h)
retiree medical account to include certain employees eligible to commence retirement
benefits under the plan upon attainment of age 59½ pursuant to section 401(a)(36).

Facts

The following facts and representations have been submitted under penalty of perjury in
support of the rulings requested:

Taxpayer maintains a pension plan, (Retirement Plan A), that was established in Year 1
and received a favorable determination letter on Date 1. Retirement Plan A maintains a
retiree medical account described in section 401(h) (Retirement Plan A's 401(h)
account).

Taxpayer represents that Retirement Plan A's 401(h) account was funded in Year 1
when Retirement Plan A received pension assets and 401(h) assets in a spinoff from a
predecessor plan. The predecessor plan's 401(h) account had not received a
contribution since Year 2, and Retirement Plan A's 401(h) account has not received any
further employer contributions. Taxpayer further represents that no section 420
transfers were made to Retirement Plan A's 401(h) account nor to any predecessor
plan's 401(h) account. Retirement Plan A has significantly more assets than needed to
satisfy liabilities for post-retirement medical benefits. Retirement Plan A's 401(h)
account provides for funding and payment of health benefits for Retirement Plan A
participants who are eligible to receive benefits under the Post-Employment Health
Benefit Plan. Under the Post-Employment Health Plan, participants are eligible for
benefits if they meet certain age and service criteria upon termination of employment.

Taxpayer represents that effective on Date 2, in accordance with section 401(a)(36),
Taxpayer amended Retirement Plan A to allow participants who have not yet separated
from service to begin receipt of pension benefits beginning the first of the month after
the attainment of age 59½ (those participants, along with eligible dependents, are
referred to as 401(a)(36)-Eligible Participants). A lump sum distribution of pension
benefits is not permitted, but all other benefit forms otherwise available under
Retirement Plan A may be elected.

Effective on Date 3, Taxpayer amended Retirement Plan A to permit the payment of
health benefits from the 401(h) account for 401(a)(36)-Eligible Participants who are
eligible to receive benefits under the Health and Welfare Plan, which covers Taxpayer's
active employees.

Taxpayer represents that it does not have a contractual obligation to fund health
benefits, including those provided under the Health and Welfare Plan, and the Post-
Employment Health Benefit Plan.

Ruling Requested

Taxpayer requests a ruling that the payment of health benefits from Retirement Plan A's
401(h) account for participants in Retirement Plan A who are eligible to take pension
distributions in accordance with section 401(a)(36) does not violate section 401(h) or
Treas. Reg. § 1.401-14 or otherwise cause Retirement Plan A to lose its tax-qualified
status under section 401(a).

Law

Section 401(a) describes requirements for a qualified trust that is created or organized
in the United States and forms part of a pension plan of an employer that is for the
exclusive benefit of the employer's employees or their beneficiaries. Section 501(a)
provides in pertinent part that an organization described in section 401(a) generally is
exempt from income tax.

Section 401(a)(36) provides that a trust forming part of a pension plan is not treated as
failing to constitute a qualified trust under section 401(a) solely because the plan
provides that a distribution may be made to an employee who has attained age 59½
and who is not separated from employment at the time of the distribution.

In pertinent part, section 401(h) provides that, under regulations prescribed by the
Secretary, and subject to the provisions of section 420, a pension or annuity plan may
provide for the payment of benefits for sickness, accident, hospitalization, and medical
expenses of retired employees, their spouses and their dependents, but only if—

  (1) the benefits are subordinate to the retirement benefits provided by the plan;

  (2) a separate account is established and maintained for the benefits;

  (3) the employer's contributions to the separate account are reasonable and
  ascertainable;

  (4) it is impossible, at any time prior to the satisfaction of all liabilities under the
  plan to provide the benefits, for any part of the corpus or income of such
  separate account to be (within the taxable year or thereafter) used for, or diverted
  to, any purpose other than the providing of the benefits; and

  (5) notwithstanding the provisions of subsection (a)(2), upon the satisfaction of all
  liabilities under the plan to provide the benefits, any amount remaining in the
  separate account must, under the terms of the plan, be returned to the employer.

Treas. Reg. § 1.401-14(a) provides that, under section 401(h), a qualified pension or
annuity plan may make provision for the payment of sickness, accident, hospitalization,
and medical expenses for retired employees, their spouses, and their dependents. The
term "medical benefits described in section 401(h)" is used in this section to describe
such payments.

Treas. Reg. § 1.401-14(b)(1) provides that, under section 401(h), a qualified pension or
annuity plan may provide for the payment of medical benefits described in section
401(h) only for retired employees, their spouses, or their dependents. To be "retired" for
purposes of eligibility to receive medical benefits described in section 401(h), an
employee must be eligible to receive retirement benefits provided under the pension
plan, or else be retired by an employer providing such medical benefits by reason of
permanent disability. For purposes of the preceding sentence, an employee is not
considered to be eligible to receive retirement benefits provided under the plan if he is
still employed by the employer and a separation from employment is a condition to
receiving the retirement benefits.

Analysis

The second sentence of Treas. Reg. § 1.401-14(b)(1) provides that an employee is
eligible as a "retired employee" to receive medical benefits from a 401(h) account if the
employee is eligible to receive retirement benefits under the associated pension plan.
Here, the 401(a)(36)-Eligible Participants are eligible to receive retirement benefits
under the terms of Retirement Plan A. Thus, the 401(a)(36)-Eligible Participants satisfy
the definition of a "retired employee" as described in the second sentence of Treas.
Reg. § 1.401-14(b)(1).

The third sentence of Treas. Reg. § 1.401-14(b)(1) provides that an employee is not
considered to be eligible to receive retirement benefits under the plan if he is still
employed by the employer and a separation from employment is a condition to receiving
the retirement benefits. Because 401(a)(36)-Eligible Participants are eligible to receive
pension benefits prior to separation from employment, separation from employment is
not a condition to the 401(a)(36)-Eligible Participants receiving retirement benefits under
Retirement Plan A. Accordingly, 401(a)(36)-Eligible Participants are not excluded from
being considered eligible to receive retirement benefits under the third sentence of
Treas. Reg. § 1.401-14(b)(1).

Ruling

We conclude that the payment of health benefits from Retirement Plan A's 401(h)
account for participants in Retirement Plan A who are eligible to take pension
distributions in accordance with section 401(a)(36) does not violate section 401(h) or
Treas. Reg. § 1.401-14 or otherwise cause Retirement Plan A to lose its tax-qualified
status under section 401(a).

The ruling contained in this letter is based upon information and representations
submitted by Taxpayer and accompanied by a penalty of perjury statement executed by
an appropriate party, as specified in Rev. Proc. 2021-1, 2021-1 IRB 1, § 7.01(16)(b).
This office has not verified any of the material submitted in support of the request for
rulings, and such material is subject to verification on examination. The Associate office
will revoke or modify a letter ruling and apply revocation retroactively if there has been a
misstatement or omission of controlling facts; the facts at the time of the transaction are
materially different from the controlling facts on which the rulings was based; or, in the
case of a transaction involving a continuing action or series of actions, the controlling
facts change during the course of the transaction. See Rev. Proc. 2022-1, § 11.05.

Except as specifically set forth above, no opinion is expressed or implied concerning the
federal tax consequences of any aspect of any transaction or item discussed or
referenced in this letter ruling. Specifically, no opinion is provided on any income tax
consequences to Taxpayer as a result of the use of the 401(h) account to provide health
benefits to the employees who have not separated from employment.

This ruling is directed only to the taxpayer requesting it. Section 6110(k)(3) provides that
it may not be used or cited as precedent.

In accordance with the Power of Attorney on file with this office, a copy of this letter is
being sent to your authorized representative.

                                            Sincerely,



                                            ______________________________
                                            Janet Laufer
                                            Senior Technician Reviewer
                                            Qualified Plans Branch 3
                                            Office of Associate Chief Counsel
                                            (Employee Benefits, Exempt
                                            Organizations, and Employment Taxes)

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