The Hidden Tax Advantage: Why Smart Business Owners Are Adopting 401(h) Plans
When it comes to retirement planning strategies for business owners, most discussions center around traditional options like 401(k)s, SEP IRAs, or defined benefit plans. However, one powerful yet underutilized tool deserves your attention: the 401(h) plan. What Is a 401(h) Plan? A 401(h) plan isn’t a standalone retirement account but rather a special medical benefit component that can be added to qualified defined benefit plans. This little-known option allows business owners to set aside tax-advantaged funds specifically for healthcare expenses in retirement. The Triple Tax Advantage The appeal of 401(h) plans lies in their remarkable tax treatment: Few retirement planning vehicles offer this “triple tax advantage” – making 401(h) plans worth serious consideration for profitable small business owners. A Real-World Example: Meet Mr. Smith To illustrate the potential benefits, let’s examine how a 401(h) plan might work for a typical business owner: Mr. Smith owns a successful small business, earning $400,000 annually (W-2) and employing five people. He currently contributes $80,000 each year to a defined benefit plan, projecting approximately $2,000,000 in retirement savings by age 65. He expects around $10,000 in annual medical expenses during retirement and falls in the 35% tax bracket. Instead of putting the entire $80,000 into his defined benefit plan, Mr. Smith decides to redirect $10,000 annually into a 401(h) plan from ages 55-65. Assuming a 5% return rate, both accounts would contain about $149,171 by retirement (comparing just the redirected portion). The Dramatic Difference Here’s where things get interesting. When Mr. Smith begins using these funds in retirement: From the 401(h) plan: From the traditional pension plan: The net benefit? An additional $127,007 in after-tax wealth that can be used for healthcare costs – simply by restructuring how he saves, not how much. Is a 401(h) Plan Right for You? A 401(h) plan makes the most sense if: Implementation Considerations While the benefits are substantial, 401(h) plans do require proper setup and administration: The Bottom Line In today’s landscape of rising healthcare costs and tax uncertainty, strategic retirement planning requires looking beyond conventional options. The 401(h) plan represents an opportunity for business owners to significantly enhance their retirement security while achieving immediate tax benefits. As with any sophisticated financial strategy, consulting with knowledgeable advisors is essential to determine if a 401(h) plan aligns with your specific situation and goals. However, for many profitable small business owners, this underutilized tool may represent one of the most efficient ways to prepare for healthcare expenses in retirement. Interested in learning whether a 401(h) plan could benefit your business? Contact our retirement planning specialists today for a complimentary consultation at 812-774-5829 or schedule an appointment online. This article is for informational purposes only and should not be construed as tax, legal, or financial advice. Always consult with qualified professionals regarding your specific situation.