Retiree Reimbursement Account: Tax Rules, Qualified Expenses, Penalties

A retiree reimbursement account, or RRA, is an employer-funded health reimbursement arrangement that pays a former employee back for qualified medical costs without those payments counting as taxable income. The retiree reimbursement account tax rules sit on three pieces of the Internal Revenue Code: Section 106 keeps the employer’s contributions out of the retiree’s gross income, Section 105 keeps the reimbursements tax-free when they cover medical care, and Section 105(h) sets the nondiscrimination tests the plan has to pass to hold onto that treatment.¹² Miss any of those pieces and reimbursements that should have been tax-free become ordinary income.

How the Account Works

An RRA is a type of Health Reimbursement Arrangement. Under IRS Notice 2002-45, which set the modern framework for HRAs, the account must be funded entirely by the employer. The retiree cannot put personal money in.³

The balance is notional. The employer books an obligation; it does not deposit cash into a segregated account the retiree owns. What the retiree holds is a promise of future reimbursement, not a pool of money they can withdraw. The funds are not portable the way an HSA is. If the former employer terminates the plan or goes under, any remaining balance is typically forfeited. A retiree carrying a $40,000 notional balance has no legal claim to that money if the plan ceases to exist, unless the plan document specifically provides for a payout at termination. There is no FDIC-style protection. That is the single biggest risk of leaning on an RRA to fund retirement health care.

One feature that makes RRAs more useful than a flexible spending arrangement: unused amounts at the end of a coverage period carry forward and increase the maximum reimbursement in later periods.³ There is no annual “use it or lose it” deadline, so a retiree with low medical costs early in retirement can build a larger balance for later years when costs climb.

Why the Reimbursements Are Tax-Free

Section 106 of the Internal Revenue Code excludes employer-provided accident and health coverage from an employee’s gross income, and IRS Notice 2002-45 extends that treatment to former and retired employees.²³ Contributions do not appear on the retiree’s W-2 or 1099. Reimbursements come out tax-free as long as they go to qualified medical care under Section 105.

There is no federally mandated cap on how much an employer can contribute. The plan document sets the amount. The tax-free treatment is conditional, though, and the conditions are where plans and retirees get into trouble.

Which Expenses Qualify

Reimbursements are tax-free only when they cover expenses that count as “medical care” under IRC Section 213(d). The IRS defines medical care broadly to include amounts paid for treating or preventing disease and amounts that affect any structure or function of the body.⁴ In practice that covers doctor visits, hospital stays, prescription drugs, dental work, vision care, and medical equipment.

For retirees, insurance premiums are often the most valuable qualifying expense. Medicare Part B premiums are explicitly included in the statute’s definition of medical care, and IRS guidance extends the same treatment to premiums for Medicare Parts A, C (Advantage plans), and D (prescription drug coverage).⁴ Deductibles, copayments, and coinsurance that Medicare doesn’t pick up also qualify.

Long-Term Care Insurance Premium Caps

Long-term care insurance premiums qualify, but only up to an age-based annual limit set by the IRS. For the 2026 tax year, the per-person caps are:

Age 40 or younger: $500
Age 41 through 50: $930
Age 51 through 60: $1,860
Age 61 through 70: $4,960
Over age 70: $6,200

Premium amounts above these caps cannot be reimbursed tax-free. The policy also has to meet the federal definition of a tax-qualified long-term care insurance contract to be eligible at all.

What Doesn’t Qualify

Cosmetic procedures that aren’t medically necessary, gym memberships without a prescription tying them to a specific condition, and general wellness supplements without a doctor’s direction fall outside the definition. Premiums already paid on a pre-tax basis through a pension plan or payroll deduction are also ineligible, because the retiree has already received a tax benefit on that spending.

The Double-Dipping Rule Retirees Trip Over

Section 105(b) catches retirees who claim the same medical expense twice. If a retiree previously deducted a medical expense on Schedule A, a later reimbursement from the RRA for that same expense becomes taxable income.¹ The statute says the tax-free exclusion doesn’t apply to amounts covered by deductions already taken under Section 213.

This is a common failure point. A retiree who itemized a large medical bill in a prior year sometimes forgets that expense has already produced a tax benefit, and submits it to the RRA anyway. The reimbursement then lands in gross income. Plan administrators should flag the issue, but the responsibility ultimately sits with the retiree. The practical rule: if you deducted it, don’t submit it.

Nondiscrimination Testing

An RRA is a self-insured medical reimbursement plan, which puts it under the nondiscrimination requirements of Section 105(h). The plan has to satisfy two tests. It cannot favor highly compensated individuals in who gets to participate, and the benefits it provides cannot be richer for highly compensated individuals than for other participants.⁵

If the plan flunks either test, the penalty doesn’t fall on the plan as a whole. The reimbursements paid to highly compensated individuals lose their tax-free status, and those individuals must include the excess reimbursements in gross income.⁵ For this purpose, a highly compensated individual is one of the five highest-paid officers, a shareholder who owns more than 10 percent of the employer’s stock, or someone in the top 25 percent of all employees by pay. Lower-paid retirees are not affected by a failed test.

If You Still Want to Contribute to an HSA

A retiree who is still covered by a High Deductible Health Plan and wants to keep making HSA contributions has to watch the plan design closely. A standard RRA that reimburses medical expenses from the first dollar counts as “other health coverage” and disqualifies the individual under Section 223.

There is a workaround. If the RRA is structured as a “post-deductible” arrangement, meaning it does not reimburse any expenses until the participant has satisfied at least the statutory minimum annual deductible for an HSA-qualifying plan, HSA contributions remain allowed. For 2026, those minimum deductibles are $1,700 for self-only coverage and $3,400 for family coverage.⁶ If the RRA and the HDHP have different deductibles, HSA contributions are limited based on the lower of the two. For family coverage, the RRA cannot reimburse any individual’s expenses before the full family HDHP deductible is satisfied, or HSA eligibility is lost. Retirees in this situation should confirm the plan design with the administrator before contributing.

Spouses, Dependents, and What Happens at Death

Spouses and dependents of the retiree can generally draw from the same account balance for their own qualified medical expenses. IRS Notice 2002-45 confirms that an HRA may reimburse the medical expenses of a deceased employee’s spouse and dependents, so coverage typically continues after the retiree’s death for people who were already covered under the plan.³ The specifics depend on the plan document, so retirees should check whether survivor access is included while they can still ask.

What the Retiree Has to Document

Every claim has to be substantiated. For a typical medical expense, that means receipts, invoices, or an Explanation of Benefits from the insurance provider.

Medicare Part B premiums get special attention. The IRS requires proof the premium was actually paid. If the premium comes out of a Social Security check, the annual Cost of Living Adjustment (COLA) statement showing the Medicare deduction amount serves as proof. If the retiree pays the premium directly, they need a copy of the Medicare bill plus a cleared check, bank statement, or credit card statement showing payment.

RRA contributions and reimbursements are not typically reported on the retiree’s W-2 or 1099. If the plan is structured improperly or reimburses non-qualified expenses, those amounts may need to be reported as taxable income, which compounds the problem.

Penalties When Something Goes Wrong

When an RRA fails to meet group health plan requirements, the employer faces an excise tax under Section 4980D of $100 per day for each affected individual, running from the date the violation begins until it is corrected. If the failure is discovered during an IRS examination and hasn’t been corrected, the minimum tax is $2,500 per individual, and for violations that are more than minor the floor jumps to $15,000 per individual.⁷

The retiree doesn’t pay the excise tax directly. The retiree’s exposure is on the income side: if the plan loses its tax-advantaged status or a particular reimbursement is deemed non-qualified, that amount gets added to gross income and taxed at ordinary rates.

One Rule Retiree-Only Plans Don’t Have to Worry About

The Affordable Care Act’s market reform requirements generally don’t apply to a plan that covers only retirees. Federal guidance confirms that group health plans with fewer than two participants who are current employees are exempt.⁸ An RRA limited to retirees falls outside the ACA’s prohibition on annual dollar limits, the preventive-services mandate, and the ban on preexisting condition exclusions. Section 105(h) nondiscrimination still applies. Employers who extend the same arrangement to active employees lose the exemption for that portion.

1
Office of the Law Revision Counsel. 26 USC 105 – Amounts Received Under Accident and Health Plans
2
Office of the Law Revision Counsel. 26 USC 106 – Contributions by Employer to Accident and Health Plans
3
Internal Revenue Service. Notice 2002-45 – Health Reimbursement Arrangements
4
Office of the Law Revision Counsel. 26 USC 213 – Medical, Dental, Etc., Expenses
5
Office of the Law Revision Counsel. 26 USC 105 – Amounts Received Under Accident and Health Plans – Section 105(h)
6
Internal Revenue Service. Rev. Proc. 2025-19 – 2026 Inflation Adjusted Items
7
Office of the Law Revision Counsel. 26 USC 4980D – Failure to Meet Certain Group Health Plan Requirements
8
Centers for Medicare & Medicaid Services. Affordable Care Act Implementation FAQs – Set 3