Wringing a tax advantage out of medical costs is harder than ever.

This tax filing season, the IRS will allow taxpayers to deduct qualified medical expenses that exceed 7.5 percent of their adjusted gross income for 2018. That jumped to 10 percent of AGI this year, however, and, coupled with the new higher standard deduction, it becomes less likely that your client will continue to itemize expenses.

These changes come as the latest expected total medical cost for a retired couple nears $300,000, with the total expected to be near a half-million dollars within the next decade.

Wealthy clients who own a business, however, have a little-known option to deal with such costs. Section 401(h) of the Internal Revenue Code provides for accounts for paying for medical-related expenses during retirement. Once established, often in conjunction with other retirement plans such as a cash balance plan, 401(h)s offer tax advantages: contributions are tax deductible; funds grow tax-free; and withdrawals by retired beneficiaries are not taxed.

“The 401(h) is one of the most advantageous qualified plans available due to recent changes in the Pension Protection Act. It’s also one of the most underutilized due to the unfamiliarity with the plan,” said CPA Eric MacCollum of Hudak and Company in Wilmington, Del. “Most qualified individuals and their advisors don’t know that these plans exist.”

“Most of our clients and advisors are unaware of 401(h)s because the employer has to set up and offer this plan,” said Lawrence Pon, a CPA/CFP at Pon & Associates in Redwood City, Calif. Most clients are aware of flexible spending accounts and arrangements, and health savings accounts, “but 401(h)s are different,” he said. Unlike an HSA, for instance, beneficiaries can inherit the account and continue to take advantage of the tax-free health-care account. Similar to an HSA, 401(h) plans also cover dependents.

“It’s definitely a great alternative for people who can’t deduct their medical expenses, [but] you’d typically want to target highly compensated employees,” said Nick Preusch a CPA and tax manager with PBMares in Fredericksburg, Va. “It really helps our highly compensated employees who may have maxed out other retirement plan options.”

Physicians aged 40 to 70 are often cited as the best candidates for 401(h) plans.

Wealthy clients, however, often think that since they already have an FSA and/or an HSA that they don’t need a 401(h). The latter doesn’t have the restrictions of an FSA, Pon pointed out, such as a use-it-or-lose-it provision.

The list of approved 401(h) plan health-care expenses is also “wider than most people think,” MacCollum added. “While it’s commonly understood that the money can be used to cover routine doctor visits, medically necessary equipment and typical health-care expenses, it can also be used for elective cosmetic procedures, spa treatments, fitness programs and insurance premiums.” Money in the 401(h) can also be passed on to beneficiaries tax-free and used for the same purposes.

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