In-service employees age 59½ may draw 401(h) retiree medical benefits without disqualifying the pension plan

Plain-English summary

A company runs a defined-benefit pension plan that includes "401(h) accounts," a feature that lets a pension plan pay retiree medical benefits. It amended the plan to let employees who are at least age 59½ start drawing their pension while still working (an "in-service distribution," which section 401(a)(36) specifically allows), and to let those same employees receive medical benefits from the 401(h) accounts. The concern was whether paying medical benefits to people who are still employed would break the rule that 401(h) benefits go only to "retired" employees, which could disqualify the whole pension plan. The regulation defines "retired" as being eligible to receive retirement benefits, and says an employee is not eligible only if separation from employment is a condition of those benefits. Because the amendment lets these age-59½ employees receive pension benefits without separating, they count as "retired" for this purpose. The IRS ruled the arrangement does not violate section 401(h) or the regulation and does not cost the plan its tax-qualified status. This clarifies that pairing in-service pension distributions with 401(h) medical benefits is permissible.

Ruling snapshot

• Question: Does paying 401(h) medical benefits to in-service employees who are eligible for pension distributions at age 59½ violate section 401(h) or disqualify the pension plan?
• Outcome: approved
• 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: 202451017                                             Third Party Communication: None
 Release Date: 12/20/2024                                      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-113164-24
                                                               Date:
                                                               September 19, 2024




Legend

Taxpayer                           = -------------------------
Parent                             = -----------------------
Pension Plan                       = ---------------------------------------------------------
Date 1                             = --------------------------
Date 2                             = ----------------
Date 3                             = ------------------
Date 4                             = ----------------------


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

This is in response to your letter, 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 accounts 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:

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

The Taxpayer maintains a Pension Plan, a defined benefit pension plan. The Pension
Plan was established effective Date 1 and was most recently restated effective Date 2.

The Pension Plan received its most recent IRS determination letter on Date 3. The
Pension Plan was designed in accordance with the applicable tax-qualification
requirements of the Code. The Pension Plan includes two section 401(h) retiree medical
accounts (Pension Plan’s 401(h) Accounts).

The Taxpayer also maintains a retiree medical benefit plan covering eligible retired
employees and their dependents (Retiree Medical Plan) and an active medical benefit
plan covering eligible active employees and their dependents (Active Medical Plan).

The Pension Plan currently funds medical benefits under the Retiree Medical Plan for
certain Pension Plan participants (Current 401(h) Account Individuals). No Current
401(h) Account Individuals are collectively bargained employees.

The Taxpayer amended the Pension Plan, effective Date 4, to allow certain Pension
Plan participants who have attained age 59 ½ and are not members of a collective
bargaining agreement (Age 59 ½-Eligible Employees) to elect to commence receipt of
payment of retirement income from the Pension Plan while such employees remain
employed by the Taxpayer. All forms of benefit payment available under the Pension
Plan will be available to the Age 59 ½-Eligible Employees.

The Taxpayer also amended the Pension Plan to permit the Pension Plan’s 401(h)
Accounts to fund medical benefits for the Age 59 ½-Eligible Employees (including their
spouses and dependents). The Age 59 ½-Eligible Employees participate in the Active
Medical Plan until their retirement and, if eligible, they participate in the Retiree Medical
Plan upon retirement.

The Taxpayer represents that the Taxpayer does not have a contractual obligation to
fund medical benefits to Current 401(h) Account Individuals or the Age 59 ½-Eligible
Employees.

The Taxpayer represents that no section 420 transfers were made to the Pension Plan’s
401(h) Accounts or the 401(h) accounts of any predecessor pension plan.

Ruling Requested

The Taxpayer requests a ruling that the payment of medical benefits from the Pension
Plan’s 401(h) Accounts for Pension Plan participants who are eligible to take pension
distributions in accordance with section 401(a)(36) does not violate section 401(h) or
§ 1.401-14 or otherwise cause the Pension Plan to lose its 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 59 ½ and who is not separated from employment at the time of the
distribution.

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
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.

   (6) The plan must expressly provide that in the event an individual’s interest in the
       medical benefits account is forfeited prior to termination of the plan an amount
         equal to the amount of the forfeiture must be applied as soon as possible to
         reduce employer contributions to fund the medical benefits described in section
         401(h).


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. The Pension
Plan will allow the Age 59 ½-Eligible Employees to elect to commence receipt of
payment of retirement income from the Pension Plan. Under the terms of the Pension
Plan, as amended, the Age 59 ½-Eligible Employees 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 the Taxpayer amended the Pension Plan to allow the Age 59 ½-
Eligible Employees to receive retirement benefits under the terms of the Pension Plan
prior to their separation from employment, separation from employment is not a
condition to the Age 59 ½-Eligible Employees receiving retirement benefits under the
Pension Plan. Accordingly, the Age 59 ½-Eligible Employees are not excluded from
being considered eligible to receive retirement benefits under the third sentence of
§ 1.401-14(b)(1).

Ruling

We conclude that the payment of medical benefits from the Pension Plan’s 401(h)
Accounts for Pension Plan participants who are eligible to take pension distributions in
accordance with section 401(a)(36) does not violate section 401(h) or § 1.401-14 or
otherwise cause the 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 the Taxpayer and accompanied by penalty of perjury statement executed
by an appropriate party, as specified in Rev. Proc. 2024-1, 2024-1 IRB 1, section
7.01(16)(b). 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 the Taxpayer as a result of the use of the Pension Plan’s 401(h)
Accounts 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.

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)


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