Calling Entrepreneurs: Want a Tax Free Health Benefit?

A little known part of the tax code, Section 401(h), permits a pension or annuity plan to provide for payment of benefits for sickness, accident, hospitalization and medical expenses for retired employees, their spouses and dependents. In order for the pension or annuity plan to meet the provisions of section 401(h), such medical benefits must be subordinate to pension benefits and must be established and maintained in a separate account. In sum, this is all good news for many entrepreneurs looking for tax free health benefits.

Medical benefits provided in a pension plan are considered ancillary benefits. Some of the special requirements are variations on the “incidental benefit” rules that have always been a concern for qualified pension plans (defined benefit plans). Thus, the contribution limitation described in section 401(h) is referred to as the “subordination limit,” since its purpose is to insure that medical contributions are subordinate to the contributions for pension benefits. Failure to meet such requirements is a qualification issue for the pension plan of which the section 401(h) medical account is a part.

Currently, many employers use both a VEBA and section 401(h) account to fund and deduct these benefits. Utilizing a section 401(h) account in conjunction with a VEBA permits employers to fund and deduct a greater amount of contributions than either arrangement would individually provide. It should be noted that in most instances, the contribution can be no more than 25% of…