In Private Letter Ruling 202547007, the IRS confirms that retirees whose pension benefits have been annuitized can remain eligible for medical benefits from their employer’s Internal Revenue Code (IRC) section 401(h) account. Under IRC rules, a section 401(h) account can only pay medical benefits for employees who are eligible to receive a pension or who are permanently disabled.
This ruling is important for plans with section 401(h) accounts because excluding annuitized participants could reduce the number of retirees to whom medical benefits could be paid from the 401(h) account, thus limiting the plan sponsor’s ability to use 401(h) assets.
In recent years, many employers have taken steps to “de-risk” their pension plans by adopting lump sum windows or, through the use of an annuity contract, transferring the liabilities for some retired participants to an insurance company that then becomes responsible for paying pension benefits to the retired employees. After the plan pays a lump sum or purchases the annuity covering the liabilities, retirees are no longer treated as “participants” for purposes of ERISA. However, in this recent ruling, the IRS confirmed that annuitized retirees satisfy the definition of “retired” for purposes of section 401(h), thus allowing the continued use of section 401(h) assets to pay for their medical benefits.
Unfortunately, the recent ruling did not address a related question regarding whether surplus pension assets can be transferred pursuant to IRC section 420 to provide medical benefits to retirees who previously received a lump sum or who were annuitized. A 2015 IRS private letter ruling provided that such participants still qualify to receive retiree medical benefits from the section 401(h) account and can be considered in determining the permissible amount of qualified transfers of surplus pension assets. However, since that 2015 ruling, in several situations the IRS has declined to rule on the section 420 issue. Based on this most recent IRS ruling, it does not appear that the IRS position on section 401(h) payments to participants whose benefits have been settled has changed; however, the ruling did not address section 420 transfers, and so the IRS’s position on whether pension surplus could be transferred to the section 401(h) account with respect to participants who have received lump sums or have been annuitized remains unclear.
Employers that maintain a pension plan with a section 401(h) account should understand this ruling and its limitations (i.e., it does not clarify whether the IRS has changed its position on allowing assets to be transferred in a section 420 transfer to a section 401(h) account for the purpose of paying retiree medical benefits for participants whose pension benefits had previously been paid out or annuitized). Note, too, that this ruling only applies to the recipient, so any employer seeking to use section 401(h) assets for participants whose benefits have been settled should consult with legal counsel and consider requesting a ruling from the IRS.
