Retirement planning in the U.S. involves navigating a maze of options—401(k)s, IRAs, Roth accounts, and more. But one lesser-known yet powerful tool is the 504 Retirement Plan. While not as mainstream as other retirement vehicles, the 504 plan serves a unique purpose for certain investors. In this guide, I break down what a 504 retirement plan is, how it compares to other retirement accounts, and whether it might be the right fit for you.
Table of Contents
What Is a 504 Retirement Plan?
The term “504 Retirement Plan” often causes confusion because it isn’t a standard IRS-defined retirement account like a 401(k) or IRA. Instead, it typically refers to a profit-sharing plan or defined benefit plan established under Section 504 of the Internal Revenue Code. These plans are primarily used by small businesses, self-employed individuals, and professionals like doctors or lawyers who want higher contribution limits than traditional plans offer.
Unlike a 401(k), where contributions are primarily employee-driven, a 504 plan allows employers to make substantial tax-deductible contributions on behalf of employees. The key advantage? Higher contribution limits—sometimes exceeding $200,000 per year—making it ideal for high-income earners looking to maximize retirement savings.
How Does a 504 Retirement Plan Work?
A 504 plan operates as either a defined benefit plan or a profit-sharing plan (a type of defined contribution plan). Here’s how each works:
1. Defined Benefit Plan Under Section 504
A defined benefit plan promises a specific payout at retirement, based on salary history and years of service. Contributions are actuarially determined to ensure the promised benefit is funded.
Key Features:
- Fixed Retirement Benefit: The plan guarantees a set monthly payment upon retirement.
- Employer-Funded: The employer bears the investment risk and must make required contributions.
- High Contribution Limits: Allows much larger tax-deductible contributions than a 401(k).
Example Calculation:
If a 55-year-old doctor wants a $150,000 annual retirement benefit starting at age 65, the required annual contribution might be around $200,000, depending on actuarial assumptions. The exact formula involves present value calculations:
Where:
- PV = Present value (required funding today)
- PMT = Annual retirement benefit ($150,000)
- r = Discount rate (assumed 5%)
- n = Years until retirement (10)
Plugging in the numbers:
PV = \frac{150,000}{(1 + 0.05)^{10}} \approx \$92,078This means the employer must contribute enough over 10 years to reach this present value, adjusted for investment growth.
2. Profit-Sharing Plan Under Section 504
A profit-sharing plan allows employers to contribute a portion of profits to employee retirement accounts. Contributions are discretionary but must follow a set formula.
Key Features:
- Flexible Contributions: Employers decide how much to contribute each year (up to 25% of compensation).
- Employee Accounts: Funds grow tax-deferred until withdrawal.
- Combination with 401(k): Often used alongside a 401(k) for added benefits.
Example Calculation:
If a business owner earns $300,000 and wants to contribute the maximum 25%:
This is far above the 2024 401(k) limit of $23,000 (or $30,500 with catch-up).
504 Plan vs. Other Retirement Accounts
To understand where the 504 plan fits, let’s compare it to common alternatives:
| Feature | 504 Defined Benefit Plan | 401(k) | SEP IRA |
|---|---|---|---|
| Max Contribution (2024) | $265,000+ (actuarially determined) | $23,000 ($30,500 catch-up) | 25% of compensation, up to $69,000 |
| Employer Contributions | Required | Optional (match) | Required (if self-employed) |
| Employee Contributions | Not allowed | Yes (pre-tax/Roth) | No |
| Best For | High-income professionals, small business owners | Employees at companies offering 401(k)s | Self-employed, small businesses |
Why Choose a 504 Plan?
- For High Earners: If you make $300,000+ and want to stash away more than a 401(k) allows.
- For Business Owners: If you want to contribute large sums while reducing taxable income.
- For Late Savers: If you’re in your 50s with little saved, a defined benefit plan can accelerate retirement savings.
Tax Advantages of a 504 Retirement Plan
One of the biggest draws is the tax deduction. Contributions reduce taxable income, and earnings grow tax-deferred. Withdrawals in retirement are taxed as ordinary income.
Example Scenario:
A consultant earning $400,000 contributes $150,000 to a 504 plan. Their taxable income drops to $250,000, potentially saving them $55,500 in taxes (assuming a 37% marginal rate).
Potential Drawbacks
- Complexity: Requires actuarial calculations for defined benefit plans.
- Cost: Higher administrative fees than a 401(k) or IRA.
- Commitment: Defined benefit plans require consistent funding, even in bad years.
Is a 504 Retirement Plan Right for You?
If you’re a high-income professional or business owner looking to maximize retirement savings, a 504 plan is worth considering. However, if you’re an employee at a company with a 401(k), sticking with that (plus an IRA) may suffice.
Final Thoughts
The 504 retirement plan is a powerful but underutilized tool. While it demands more effort and cost than mainstream options, the tax benefits and high contribution limits make it a compelling choice for the right candidate. If you’re unsure, consult a financial advisor to weigh the pros and cons for your situation.
