IRS rules on qualified pension plan, medical account distributions

The IRS recently issued guidance (PLR 202305001) providing that a separate account maintained under a qualified pension plan to pay medical benefits only for retired employees could be used to provide medical benefits to active employees who are eligible to commence in-service retirement benefits under the plan.

These retiree medical accounts are known as Section 401(h) accounts, as Section 401(h) expressly authorizes the accounts and imposes specific conditions and limitations on such accounts. One of the conditions generally allows Section 401(h) accounts to only be used to provide medical benefits to retired employees, their spouses and dependents.

The regulations provide that to be considered “retired,” an employee generally must be eligible to receive retirement benefits under the pension plan. The regulations provide further that an employee is not considered eligible for retirement benefits if the employee is still employed by the employer and a separation from employment is a condition to receiving retirement benefits.

Prior to the enactment of Section 401(a)(36) by the Pension Protection Act of 2006 (P.L. 109-280), a qualified pension plan generally could not commence retirement benefits until a participant experienced a separation from employment. Thus, in-service distributions to active employees — even those with a reduced work schedule to phase into retirement — could not be made.

Section 401(a)(36) allowed plan sponsors to make in-service distributions to active employees who attained age 62. This age was subsequently reduced to 59-and-a-half by the Bipartisan American Miners Act.

The IRS concluded in the PLR that the conditions to be considered “retired” were met by active employees who were eligible to commence “in-service Section 401(a)(36) distributions” because their eligibility to commence retirement benefits under the terms of the plan was not conditioned on their separation from employment.

The IRS noted in the PLR that the particular Section 401(h) account involved in the ruling had significantly more assets than needed to satisfy liabilities for post-retirement medical benefits — meaning the Section 401(h) account was significantly overfunded. It is not clear whether the IRS would reach the same conclusion if a particular Section 401(h) account was not significantly overfunded. Nevertheless, in this ruling, the plan sponsor can now use the “retiree” Section 401(h) account to provide medical benefits to certain active employees.