True-Ups: What are they and how are they determined?

You've been funding 401(K) matching contributions, but you just learned you must make an additional “true-up” contribution. What does this mean and how was it determined?

Employer matching contributions are a great benefit and can help attract and retain employees. It’s not unusual for employers to fund matching contributions each pay period, even though the plan document requires that the matching contribution be calculated on an annualized basis. This means that the matching contribution will need to be calculated both ways (pay period versus annualized) and may result in different matching contribution amounts to certain participants, especially those whose contribution amounts varied throughout the year.

For many employers (and payroll systems), the per-pay-period matching contribution method can be easier to administer and help with company cash flow. Employer matching contributions are calculated based on each employee’s earnings and contributions per pay period. However, this method can create problems for employees who max out their 401k contributions early, as we will see below.

Per-pay-period match: Consistent 401(k) contributions throughout the year

Suppose a company matches dollar-for dollar-on the first 4% of pay and pays employees twice a month for a total of 24 pay periods in a year. The per period gross pay of an employee with an annual salary of $120,000, then, is $5,000. If the employee makes a 4% contribution to their 401(k) plan, their $200 per pay period contribution will be matched with $200 from the company.

Per-pay-period matching contribution methodology for $120K employee contributing 4% for full year 
Employee contribution Employer matching contribution Total
Contributions per pay period $200 $200 $400
Full year contributions $4,800 $4,800 $9,600

For the full year, assuming the 401(k) contribution rate remains constant, this employee would contribute a total of $4,800 and receive $4,800 from their employer, for a total of $9,600.

Per-pay-period match: Maxing out 401(k) contributions early

Employees are often encouraged to optimize their 401(k) benefit by contributing the maximum allowable amount to their plan. Suppose instead that this same employee is enthusiastic about this suggestion and, determined to maximize their 401(k) contribution, elects to contribute 20% of their paycheck to the company’s 401(k) plan. Sounds great, right?

At this rate, however, assuming the employee is younger than age 50, the employee would reach the $19,500 annual 401(k) contribution limit during the 20th pay period. Their contributions to the plan would stop, but so too would the employer matching contributions, even though the company had only deposited $3,800 into this employee’s account, — $1,000 less than the amount that would have been received if the employee had spread their contributions throughout the year and received the full matching contribution for every pay period.

Per-pay-period matching contribution methodology for $120K employee contributing 20% from beginning of year
Employee contribution Employer matching contribution Total
Contributions per pay period $1,000 $200 $1,200
Full year contributions $19,500 $3,800 $23,300

Employees who max out too soon on their own contributions are at risk of missing out on the full employer matching contribution amount. This can happen if the contribution rate or compensation (due to bonuses, for instance) varies throughout the year.

True-up contributions using annualized matching calculation

When the plan document stipulates that the matching contribution calculation will be made on an annualized basis, plans who match each pay period will be required to make an extra calculation after the end of the plan year. The annualized contribution amount is based on each employee’s contributions and compensation throughout the entire plan year.

The difference between these annualized calculations and those made on a per-pay-period basis will be the “true-up contributions” required for any employees who maxed out their 401(k) contributions early and therefore missed out on the full company matching contribution.

In the example above, the employee would receive a true-up contribution of $1,000 in the following year.

Plans with the annualized employer matching contribution requirement (per their plan document) may still make matching contributions each pay period, but during compliance testing, which is based on annual compensation, matching amounts are reviewed and true-ups calculated as needed. The true-up contribution is normally completed within the first two months following the plan year end and before the company’s tax filing deadline.

Making true-up contributions means employees won’t have to worry about adjusting their contribution percentages to make sure they don’t max out too early. Employees can front-load their 401k contributions and still receive the full matching contribution amount.

Often true-up contributions affect senior managers or business owners; hence companies are reluctant to amend their plan to a per-pay-period matching contribution calculation. That said, employers should be prepared to make true-up contributions and not be surprised when they are required.