Rev. Rul. 2026-22, October 28, 2026

In Revenue Ruling 2026-22, the Internal Revenue Service addresses a critical intersection between retiree health benefit accounts under Internal Revenue Code (I.R.C.) § 401(h) and in-service distribution provisions under I.R.C. § 401(a)(36). The IRS formally rules that a qualified pension plan may utilize surplus assets held in a § 401(h) retiree medical account to fund active medical plan benefits for current employees who have attained age 59½ and are eligible for in-service retirement distributions. The ruling confirms that utilizing surplus 401(h) assets for these active, working participants does not violate the statutory mandates of I.R.C. § 401(h) or Treasury Regulation (Treas. Reg.) § 1.401-14, nor does it adversely affect the plan’s tax-qualified status under I.R.C. § 401(a).

Background and Purpose of the Guidance

Sponsors of qualified defined benefit pension plans frequently establish I.R.C. § 401(h) retiree medical accounts to provide tax-advantaged funding for medical expenses of retired participants, their spouses, and dependents. Under stringent tax qualification rules, assets held in a § 401(h) account are subject to rigorous exclusive benefit and non-diversion requirements prior to the full satisfaction of all plan liabilities. Historically, overfunded 401(h) accounts presented a structural challenge for plan sponsors: surplus funds remained locked within the separate account, unavailable for general active health obligations, while active employee health coverage costs continued to escalate.

Following legislative amendments codified in I.R.C. § 401(a)(36), qualified pension plans are permitted to allow active participants who have reached age 59½ to receive in-service pension distributions without terminating employment. The IRS issued Revenue Ruling 2026-22 to resolve a key technical legal question: whether active employees who are eligible for in-service distributions under I.R.C. § 401(a)(36) satisfy the regulatory definition of “retired” under Treas. Reg. § 1.401-14(b)(1) solely for the purpose of receiving medical benefits funded by a § 401(h) account.

Factual Context of the Revenue Ruling

The IRS evaluated a specific factual matrix involving Company A and its qualified defined benefit plan, Plan Z:

Plan Structure and 401(h) Account: Company A sponsors Plan Z, a pension plan qualified under I.R.C. § 401(a) and exempt from tax under I.R.C. § 501(a). Plan Z contains a separate I.R.C. § 401(h) retiree medical account (“401(h) Account”).
Retiree Health Coverage: Company A maintains a Retiree Medical Plan providing health benefits to retired employees who have separated from service, as well as their spouses and dependents. The 401(h) Account funds retiree health benefits under this plan for eligible Plan Z participants (excluding key employees as defined in I.R.C. § 416(i)).
In-Service Pension Distribution Provisions: Pursuant to I.R.C. § 401(a)(36), Plan Z permits participants who have attained age 59½ and have not separated from employment with Company A (“401(a)(36)-Eligible Participants”) to elect in-service pension distributions in any available optional payment form, including a lump-sum option.
Active Health Coverage: Company A maintains an Active Medical Plan covering eligible active employees and their dependents, under which the 401(a)(36)-Eligible Participants are actively covered.
Funding and Overfunding Status: The 401(h) Account is “substantially overfunded.” Company A has never executed transfers under I.R.C. § 420 into the account. Furthermore, Company A possesses no contractual obligation to fund medical benefits for either retired or active employees.
Proposed Amendment: Company A amends Plan Z to permit surplus assets in the 401(h) Account to fund active medical benefits under the Active Medical Plan for non-key 401(a)(36)-Eligible Participants and their spouses and dependents.

As framed by the IRS, the legal issue presented is:

“Does the use of a pension plan’s section 401(h) account assets to pay for medical benefits described in section 401(h) of plan participants who, in accordance with section 401(a)(36) of the Internal Revenue Code (Code), have not separated from employment but are eligible to take in-service distributions upon attainment of age 59½, violate section 401(h) or § 1.401-14, or adversely affect the plan’s tax-qualified status under section 401(a)?”

Applicable Statutory and Regulatory Architecture

The IRS’s legal framework relies upon the interplay between statutory qualification rules and regulatory eligibility definitions:

Statutory Qualification Standard: I.R.C. § 401(a)(36)

I.R.C. § 401(a)(36) establishes that:

“a trust forming part of a pension plan shall not be treated as failing to constitute a qualified trust under section 401 solely because the plan provides that a distribution may be made from the trust to an employee who has attained age 59½ and who is not separated from employment at the time of the distribution.”

Statutory Framework for Retiree Medical Benefits: I.R.C. § 401(h)

Under I.R.C. § 401(h), a qualified pension or annuity plan may provide for the payment of sickness, accident, hospitalization, and medical expenses for “retired employees, their spouses, and their dependents,” provided six statutory conditions are met:

Subordination: Medical benefits must be subordinate to the plan’s retirement benefits (I.R.C. § 401(h)(1)).
Separate Account Requirement: A separate account must be established and maintained for medical benefits (I.R.C. § 401(h)(2)).
Reasonable and Ascertainable Contributions: Employer contributions to the separate account must be reasonable and ascertainable (I.R.C. § 401(h)(3)).
Non-Diversion Requisite: Prior to satisfying all plan liabilities to provide medical benefits, no part of the account’s corpus or income may be used or diverted for any other purpose (I.R.C. § 401(h)(4)).
Reversion of Residual Assets: Upon satisfaction of all medical liabilities, remaining amounts must return to the employer (I.R.C. § 401(h)(5)).
Key Employee Accounts: Separate accounts must be maintained for key employees under I.R.C. § 416(i), and post-1984 medical benefits for key employees must be paid exclusively from their individual accounts (I.R.C. § 401(h)(6)).

Regulatory Definition of “Retired”: Treas. Reg. § 1.401-14

Treasury Regulation § 1.401-14(b)(1) limits the payment of § 401(h) medical benefits strictly to “retired employees, their spouses, or their dependents.” To determine who constitutes a “retired employee,” Treas. Reg. § 1.401-14(b)(1) establishes a precise test:

“To be ‘retired’ for purposes of eligibility to receive medical benefits described in section 401(h), an employee must be eligible to receive retirement benefits provided under the pension plan, or else be retired by an employer providing such medical benefits by reason of permanent disability.”

Treas. Reg. § 1.401-14(b)(1) immediately qualifies this definition in its third sentence:

“For purposes of the preceding sentence, an employee is not considered to be eligible to receive retirement benefits provided under the plan if the employee is still employed by the employer and a separation from employment is a condition to receiving the retirement benefits.”

Additionally, Treas. Reg. § 1.401-14(c) reinforces the six operational requirements regarding benefit specification, subordination, separate accounting, non-diversion, residual returns, and mandatory application of forfeitures to reduce employer contributions.

Legal Analysis and Synthesis

The core legal synthesis in Revenue Ruling 2026-22 turns on the precise mechanics of Treas. Reg. § 1.401-14(b)(1).

Under the general regulatory rule, an active employee is disqualified from being considered “retired” because pension plans historically required a severance from employment as a condition precedent to receiving retirement benefit distributions. The third sentence of Treas. Reg. § 1.401-14(b)(1) explicitly constructs a negative rule: an active employee is excluded from eligibility only if separation from employment is a mandatory condition to receive plan retirement benefits.

However, when a pension plan adopts in-service distribution provisions under I.R.C. § 401(a)(36), separation from employment is explicitly removed as a condition precedent to pension benefit eligibility for participants reaching age 59½. Consequently, active participants attaining age 59½ become immediately “eligible to receive retirement benefits provided under the pension plan” while remaining on active payroll. Because separation from service is no longer a prerequisite to pension entitlement, the disqualifying exception of the third sentence in Treas. Reg. § 1.401-14(b)(1) is rendered inapplicable.

As the IRS explains in its analysis:

“Plan Z allows 401(a)(36)-Eligible Participants to elect to commence receipt of payment of retirement benefits from Plan Z. Because a separation from employment is not a condition to receiving the retirement benefits, the 401(a)(36)-Eligible Participants are eligible to receive retirement benefits under Plan Z, even though they are still current employees of Company A. Accordingly, the 401(a)(36)-Eligible Participants who are still active employees satisfy the definition of ‘retired’ as described in the second sentence of § 1.401-14(b)(1) and are not excluded from being considered eligible to receive retirement benefits under § 1.401-14(b)(1).”

Technical Application to the Plan Z Factual Matrix

Applying these legal standards to Company A’s plan amendment yields the following technical outcomes:

Qualification under Treas. Reg. § 1.401-14(b)(1): Active employees aged 59½ or older who are eligible for in-service distributions meet the regulatory definition of “retired” solely for § 401(h) benefit eligibility.
Compliance with Non-Diversion Rules (I.R.C. § 401(h)(4)): Using surplus 401(h) assets to pay active medical expenses for 401(a)(36)-Eligible Participants does not constitute an impermissible diversion of funds. Because these participants satisfy the definition of “retired” under § 1.401-14(b)(1), funding their medical benefits constitutes providing “such benefits” authorized by I.R.C. § 401(h).
Key Employee Exclusion Compliance: Because Plan Z’s 401(h) Account does not fund benefits for key employees under I.R.C. § 416(i), and the plan amendment limits active medical funding strictly to non-key 401(a)(36)-Eligible Participants, the strict individual separate accounting constraints of I.R.C. § 401(h)(6) are fully preserved.
Scope Limitation: The IRS expressly restricts the reach of this legal characterization, stating:

“However, no implications are intended regarding whether the 401(a)(36)-Eligible Participants are treated as retired for any other purpose under the Code.”

Holding and Tax Practitioner Takeaways

The IRS concludes with the following holding:

“The use of assets from Plan Z’s 401(h) Account to pay for medical benefits described in section 401(h) of 401(a)(36)-Eligible Participants who have not separated from employment but are eligible to take in-service distributions upon attainment of age 59½, does not violate section 401(h) or § 1.401-14, or adversely affect the plan’s tax-qualified status under section 401(a).”

Key Takeaways for Tax Professionals

Plan Amendment Opportunity: Sponsors of defined benefit plans with overfunded § 401(h) accounts can amend their plan documents to permit age 59½ in-service distributions under I.R.C. § 401(a)(36) and simultaneously authorize 401(h) surplus assets to pay active medical expenses for these active 59½+ employees.
Surplus De-escalation Mechanism: This mechanism allows plan sponsors to efficiently deploy trapped surplus 401(h) assets to subsidize employer health care costs for eligible active employees without triggering prohibited diversion penalties or excise taxes under the Code.
Strict Operational Guardrails: Practitioners must verify that the plan explicitly excludes key employees (I.R.C. § 416(i)) unless separate key employee accounts are properly maintained under I.R.C. § 401(h)(6), and that medical benefits remain strictly subordinate to overall retirement benefits under Treas. Reg. § 1.401-14(c)(1).
Narrow Definition Scope: Practitioners must take care not to treat active age 59½+ participants as “retired” for other tax or benefit provisions (e.g., FICA/FUTA tax treatment, distributions under I.R.C. § 72(t), or active health plan nondiscrimination testing under I.R.C. § 105(h)).

Prepared with assistance from Gemini Notebook.