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Use A 401(h) Plan to Remove Money TAX FREE From a Pension Plan

By Roccy M. DeFrancesco, JD,CWPP, CAPP, MMB - Email Editor

Date : October 6, 2009

Let me start with a simple question: Do you know what a 401(h) plan is?

I had no idea what a 401(h) plan was until my pension administrator, John Lalonde, told me about it. My guess is that 99 percent of those who read this newsletter have never heard of a 401(h) plan; (so this newsletter should be helpful to those looking for unique and useful marketing tools).

One of the largest expenses for retired EEs is their health-care costs. How do retired EEs pay for such costs? Typically, with savings or out of their taxable income.

With a 401(h) plan, an employer can take a 100% deduction to fund a tax-free sinking fund. When retired EEs remove money from the plan to pay for medical expenses, there are NO income taxes due.

Is a 401(h) plan practical and should you recommend them? Absolutely. Let me show you with an example.

Example: Assume Dr. Smith earns $400,000 a year (W-2) and has five employees of various ages and salaries. Dr. Smith has been funding in a tax-deferred manner $80,000 into a defined benefit plan every year. If he keeps doing this, he will ultimately have approximately $2,000,000 in the plan when he turns 65 years old. Assume that on average Dr. Smith will have $10,000 of medical expenses every year in retirement. Assume he is now and will be in the 35 percent income tax bracket.

How can a 401(h) plan help?

Dr. Smith could have his medical practice fund X amount of money in a tax-deductible manner into a 401(h) plan every year as an employee benefit for himself and the other employees (discrimination testing for EE contributions is done using the classic age, years of service, and salary testing guidelines).

As stated, the money is allowed to grow tax free and can then come out tax free from the 401(h) plan if used for medical expenses (including elective surgery). Therefore, instead of funding $80,000 every year into a defined benefit plan, let’s assume he allocates $10,000 of the $80,000 to the 401(h) plan from ages 55-65.

At age 65, what is the net positive benefit of using the plan?

If I assumed a 5 percent rate of return in the 401(h) plan and the pension plan, the accounts would both have the same balances when Dr. Smith hits age 65: $149,171 (I’m just comparing the $10,000 contribution made from ages 55-65).

Now let’s assume that Dr. Smith incurs $10,000 of medical expenses every year in retirement. When Dr. Smith uses $10,000 from his 401(h) plan, the money comes out 100 percent tax free. When he removes it from the defined benefit plan to pay expenses, it is 100 percent taxable.

How do the numbers compare?

From the 401(h) plan, he could remove $10,000 a year tax free until he turns age 90.

However, because he would have to remove $15,384 from his taxable pension plan to net $10,000 after tax, he would run out of money in this example at age 78.

Therefore, the net positive benefit to Dr. Smith when allocating $10,000 to a 401(h) plan vs. a tax-deferred plan is $127,007. This is how much more after-tax money could be removed over time using the 401(h) plan in my example.

Let me ask you again: Do you think many of your business clients would be interested in using a 401(h) plan to help plan for their retirement?

What does learning about a 401(h) plans mean to you? OPPORTUNITY!

This the prefect time of the year to talk with your clients about adding a 401(h) plan to their pension plan. Also, if you want to take planning with a 401(h) plan up a notch, wait until next week when I will discuss the power of the Super 401(k)™ plan.

If you are an advisor, you can find out more about 401(h) plans by attending a Webinar on October 15,

If you are an advisor, you can attend a webinar that we are doing at 3:00 p.m. EST on the 15th. To do so, please click here. If you simply want me to e-mail you more information on a 401(h) plan including a multi-page summary, please click here.

If you want to know more about the 401(h) plan, please e-mail info@trustmakers.com .

Circular 230 disclaimer: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.

If you would like to discuss the use of trust for you, your family, or even as a marketing tool for your business, give us a call we would love to talk with you about it. Please contact us at info@trustmakers.com

By Roccy M. DeFrancesco, JD,CWPP, CAPP, MMB
TrustMakers.com

 

 

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