Pension medical account may cover eligible active employees

Plain-English summary

An employer maintained a defined benefit pension plan with an overfunded section 401(h) account for retiree medical benefits. It proposed allowing employees age 59½ or older to begin pension distributions while still employed under section 401(a)(36), then using the medical account to fund those employees' active-plan medical benefits. The IRS reasoned that these employees would be eligible for pension benefits without separating from employment and therefore would count as retired employees for the section 401(h) regulation. It ruled that the amendments would not violate section 401(h), its regulations, or otherwise cause the pension plan to lose its qualified status. The ruling does not address other qualification requirements or the employer's income tax consequences.

Ruling snapshot

• Question: May a pension plan's section 401(h) account fund medical benefits for employees eligible for in-service pension distributions at age 59½?
• Outcome: Approved, based on the proposed plan amendments
• Key authorities: IRC §§ 401(a)(36), 401(h); Treas. Reg. § 1.401-14

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 202434004 Third Party Communication: None
Release Date: 8/23/2024 Date of Communication: Not Applicable
Index Number: 401.27-00
Person To Contact:
----------------------- --------------------, ID No. -----------------
---------------------------- Telephone Number:
---------------------
Refer Reply To:
CC:EEE:EB:QP3
PLR-101394-24
Date:
May 29, 2024

Legend

Taxpayer = -----------------------
Parent = ----------------
Pension Plan = ---------------------------------------------
Retiree Medical Plan = ----------------------------------------------------
Active Medical Plan = ------------------------------------------------------------------------------

Date 1 = ----------------------
Date 2 = -----------------
Date 3 = --------------------------
Year A = -------

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

This is in response to your letter, dated -----------------------, as supplemented by
information dated ---------------------, submitted on your behalf by your authorized
representative. The letter requests a ruling on the impact of amending a pension plan
document to expand employee eligibility for benefits under the plan’s section 401(h)
retiree medical account to include, pursuant to section 401(a)(36) of the Internal
Revenue Code (Code), certain employees eligible to commence retirement benefits
under the plan upon attainment of age 59 ½.

Facts

The following facts and representations have been submitted under penalties of perjury
in support of the rulings requested:
PLR-101394-24 2

Taxpayer is a subsidiary of Parent. Taxpayer has a fiscal calendar year accounting
period and files its tax returns under the accrual method.

Taxpayer maintains Pension Plan, a defined benefit pension plan. Pension Plan was
established on Date 1. Pension Plan received its most recent IRS determination letter
on Date 2. Pension Plan was designed in accordance with the applicable tax-
qualification requirements of the Code.

Under the current Pension Plan provisions, participants are generally eligible to receive
retirement benefits on or after their normal or early retirement age, provided the
participants have terminated. Pension Plan’s participants are therefore generally
ineligible to receive benefit payments prior to their separation from employment.

Pension Plan includes an overfunded section 401(h) account (“Pension Plan’s 401(h)
Account”), which is used to fund medical benefits for certain participants under Retiree
Medical Plan. Pension Plan provides that an “eligible retiree” for whom medical benefits
may be funded by Pension Plan’s 401(h) Account is a participant other than a key
employee (as defined by Pension Plan) who has satisfied the eligibility requirements of
and elected to receive benefits under Retiree Medical Plan and includes the lawful
spouse of the participant (if the spouse is entitled to receive benefits under Retiree
Medical Plan). The medical benefits that may be funded by Pension Plan’s 401(h)
Account are any expenses for medical care for which eligible retirees are entitled to
reimbursement under the terms of Retiree Medical Plan and any medical expense
reimbursement plan which is a part thereof. Eligibility under Retiree Medical Plan is
generally limited to a closed group of former employees who commenced employment
at a participating company before certain dates and who satisfy the other eligibility
requirements of Retiree Medical Plan.

Taxpayer represents that no contributions have been made to Pension Plan’s 401(h)
Account since Year A. Pension Plan’s 401(h) Account became overfunded primarily due
to positive investment performance and a decline in the number of eligible retirees.
Taxpayer anticipates that the funding surplus will continue to grow as the number of
eligible retirees continues to decline. Pension Plan’s 401(h) Account therefore has
significantly more assets than needed to satisfy the liabilities for medical benefits under
Retiree Medical Plan.

Taxpayer desires to use some of the surplus funds in Pension Plan’s 401(h) Account to
fund medical benefits for participants who currently participate in Pension Plan and
Active Medical Plan and who are not permitted, under the current terms of Pension
Plan, to receive retirement benefits while they remain employed but who would
otherwise be legally permitted to receive retirement benefits under section 401(a)(36).
Taxpayer wishes to use part of the surplus in Pension Plan’s 401(h) Account to fund
benefits under Active Medical Plan for these participants and their eligible spouses and
dependents.
PLR-101394-24 3

Taxpayer proposes to amend Pension Plan to allow participants (“401(a)(36)-Eligible
Participants”) to elect to receive retirement benefits under Pension Plan upon
attainment of age 59½ but prior to their separation from employment, pursuant to
section 401(a)(36) (“Proposed 401(a)(36) Amendment”). Taxpayer anticipates that all
forms of benefit payment, including a lump-sum option, would be available to
401(a)(36)-Eligible Participants.

In connection with this amendment, Taxpayer proposes to further amend Pension Plan
to allow Pension Plan’s 401(h) Account to fund medical benefits for the 401(a)(36)-
Eligible Participants, and their eligible spouses and dependents, under Active Medical
Plan (“Proposed 401(h) Amendment,” and together with Proposed 401(a)(36)
Amendment, “Proposed Amendments”). Taxpayer intends to implement Proposed
Amendments as soon as practical upon receiving an affirmative ruling from the Internal
Revenue Service.

Taxpayer represents that no section 420 transfers were made to Pension Plan’s 401(h)
Account nor any predecessor’s 401(h) account since Date 3, and that, to the best of
Taxpayer’s knowledge, no section 420 transfers were made prior to Date 3.

Taxpayer represents that Taxpayer does not have a contractual obligation to fund
medical benefits for any of the employees who would be impacted by Proposed
Amendments.

Ruling Requested

Taxpayer requests a ruling that the payment of medical benefits from Pension Plan’s
401(h) Account to fund medical benefits provided under Active Medical Plan for
401(a)(36)-Eligible Participants, as provided for in Proposed Amendments, does not
violate section 401(h) or § 1.401-14 or otherwise jeopardize Pension Plan's tax-qualified
status under section 401(a).

Law

Section 401(a) describes the requirements for a qualified trust created or organized in
the United States and forming part of a stock bonus, pension, or profit-sharing plan of
an employer for the exclusive benefit of the employer’s employees or their beneficiaries.

Section 501(a) provides that an organization described in section 401(a) is generally
exempt from federal income tax.

Section 401(a)(36) provides that a trust forming part of a pension plan shall not be
treated as failing to constitute a qualified trust under section 401 solely because the
plan provides that a distribution may be made from the trust to an employee who has
attained age 59½ and who is not separated from employment at the time of the
distribution.
PLR-101394-24 4

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) such benefits are subordinate to the retirement benefits provided by the plan;

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

(3) the employer’s contributions to such 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 such 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 such benefits;

(5) notwithstanding the provisions of section 401(a)(2), upon the satisfaction of all
    liabilities under the plan to provide such benefits, any amount remaining in such
    separate account must, under the terms of the plan, be returned to the employer;
    and

(6) in the case of an employee who is a key employee, a separate account is
    established and maintained for such benefits payable to such employee (and his
    spouse and dependents) and such benefits (to the extent attributable to plan
    years beginning after March 31, 1984, for which the employee is a key
    employee) are only payable to such employee (and his spouse and dependents)
    from such separate account.

Section 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 § 1.401-14 to describe such
payments.

Section 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
PLR-101394-24 5

still employed by the employer and a separation from employment is a condition to
receiving the retirement benefits.

Section 1.401-14(c) sets forth requirements which must be met for a qualified pension
or annuity plan to provide medical benefits described in section 401(h):

(1) The plan must specify the medical benefits described in section 401(h) which will
    be available and must contain provisions for determining the amount which will
    be paid. Such benefits, when added to any life insurance protection provided for
    under the plan, must be subordinate to the retirement benefits provided by such
    plan.

(2) A separate account must be maintained with respect to contributions to fund
    medical benefits described in section 401(h).

(3) Amounts contributed to fund medical benefits, as described in section 401(h),
    must be reasonable and ascertainable.

(4) It must be impossible, at any time prior to the satisfaction of all liabilities under
    the plan to provide for the payment of medical benefits described in section
    401(h), for any part of the corpus or income of the medical benefits account to be
    (within the taxable year or thereafter) used for, or diverted to, any purpose other
    than the providing of such benefits.

(5) The plan must provide that any amounts which are contributed to fund medical
    benefits described in section 401(h) and which remain in the medical benefits
    account upon the satisfaction of all liabilities arising out of the operation of the
    medical benefits portion of the plan are to be returned to the employer.

Analysis

The second sentence of § 1.401-14(b)(1) provides that an employee is eligible to
receive medical benefits from a 401(h) account as a “retired employee” if the employee
is eligible to receive retirement benefits under the associated pension plan. Taxpayer’s
Proposed 401(a)(36) Amendment would allow 401(a)(36)-Eligible Participants to receive
retirement benefits under the terms of Pension Plan. Upon passage of Taxpayer’s
Proposed 401(a)(36) Amendment, 401(a)(36)-Eligible Participants would therefore
satisfy the definition of a “retired employee” as described in the second sentence of
§ 1.401-14(b)(1).

The third sentence of § 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 Taxpayer’s Proposed 401(a)(36) Amendment would allow
401(a)(36)-Eligible Participants to receive retirement benefits under the terms of
PLR-101394-24 6

Pension Plan prior to their separation from employment, separation from employment
would not be a condition to 401(a)(36)-Eligible Participants receiving retirement benefits
under Pension Plan. Accordingly, 401(a)(36)-Eligible Participants would not be excluded
from being considered eligible to receive retirement benefits under the third sentence of
§ 1.401-14(b)(1).

Ruling

We conclude that adoption of Taxpayer’s Proposed Amendments, allowing the use of
payments from Pension Plan’s 401(h) Account to fund medical benefits for participants
who are eligible to take pension distributions in accordance with section 401(a)(36),
would not violate section 401(h) or § 1.401-14 or otherwise cause Pension Plan 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 penalty of perjury statements executed by
an appropriate party, as specified in Rev. Proc. 2024-1, 2024-1 I.R.B. 1, sections
7.01(16)(b) and 8.05(4). This office has not verified any of the material submitted in
support of the request for rulings. This material is subject to verification upon
examination. The Associate Office will revoke or modify a letter ruling and apply the
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 ruling 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. 2024-1, section 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 Pension Plan’s 401(h) Account to
provide health benefits to the employees who have not separated from employment. In
addition, no opinion is expressed as to whether the Pension Plan satisfies any
requirements of section 401(a) not expressly discussed.

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.
PLR-101394-24 7

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,



                                            Jeremy D. Lamb
                                            Senior Counsel
                                            Qualified Plans Branch 2
                                            Office of Associate Chief Counsel
                                            (Employee Benefits, Exempt Organizations, and
                                            Employment Taxes)

cc: ---------------------------------------------------------------
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