IRS permits surplus medical funds for workers aged 59½ or older

By Tom Whitfield

Revenue Ruling 2026-22 allows employers to use surplus funds in certain retiree medical accounts to pay health benefits for eligible employees aged 59½ or older. The IRS ruling applies under U.S. federal tax law to employees whose pension plans permit retirement benefits without separation from employment. No separate effective date was stated for the ruling.

The decision creates a funding route for qualifying medical benefits, but it does not make every surplus balance transferable. The IRS concluded that using a pension plan's Section 401(h) account this way does not violate the applicable retiree medical rules or jeopardize the plan's tax-qualified status. Employers still must satisfy the account's conditions and match the ruling's specific facts.

Which medical accounts qualify?

A Section 401(h) account lets a pension or annuity plan set aside funds for medical benefits for retired employees, their spouses and dependents. The arrangement requires separate accounting, reasonable and ascertainable contributions, and restrictions on how funds can be used. Medical benefits must remain subordinate to the plan's retirement benefits.

Groom Law Group said some employers have accumulated “substantial surpluses” while having limited options for using the excess. A change beginning in 2020 lowered the minimum age for permitted in-service pension distributions to 59½, opening a path for eligible active employees to receive account-funded medical care.

Employers seeking this route should check both pension and medical arrangements before moving money. The ruling permits a funding route, not a waiver of the 401(h) accounting and retirement-priority rules.

What did the IRS decide?

The ruling describes an employer with an overfunded 401(h) account and separate medical plans for retirees and active workers. Its pension plan allowed qualifying employees to take in-service distributions. The employer amended the plan so the medical account could fund health benefits for those employees and their families.

The decisive issue was the regulatory definition of “retired.” The ruling said employees did not have to leave their jobs to receive pension benefits. The IRS stated: “Because separation from employment was not required to receive pension benefits, the workers met that definition for purposes of Section 401(h).”

Eligibility, rather than actual pension payments, controlled the analysis. That structure depends on eligibility already present in the pension plan. An employee can count as retired under 401(h) while remaining employed when plan eligibility permits retirement benefits.

Does the ruling settle broader questions?

The ruling does not settle every variation. Its facts excluded key employees from account-funded benefits, and the 401(h) account had received no Section 420 transfers. The IRS also said treating these employees as retired for this provision has no implications for their retirement status under other tax-code provisions.

Groom Law Group said the IRS had approved similar arrangements in eight private letter rulings beginning in 2023. Employers could rely on those private rulings only when they requested them. Revenue Ruling 2026-22 provides guidance for taxpayers with substantially similar facts and gives employers considering the approach greater certainty.

Broader guidance does not remove the need to compare facts. The value is a published IRS position, not universal approval for every plan or employee population.

What should employers test now?

Before acting, employers should compare their plan documents, employee population and medical arrangements with the ruling. The review should establish:

• Whether the pension plan permits qualifying employees aged 59½ or older to take in-service distributions.
• Whether each employee meets the plan's eligibility rules even though no pension payments have begun.
• Whether the 401(h) account holds surplus and follows requirements for separate accounting, reasonable and ascertainable contributions, use restrictions and retirement priority.
• Which plan amendments would let the account fund active employees and their families.
• Whether key-employee exclusions or Section 420 transfers differ from the ruling's facts.

The example employer amended its pension plan before using the medical account for active-worker benefits. Its structure does not determine how a different employer must document plan terms or employee eligibility.

The ruling removes an IRS tax-status objection for employers with substantially similar facts. The next test is whether each employer can document that match and administer the benefit without extending 401(h) treatment beyond the circumstances the IRS addressed.