Year-End True-Ups and Unintended Consequences

We talk A LOT about getting good advice and being willing to pay for it from smart, savvy providers. Here’s a great example of why it’s so important to consider the savings behavior and demographics of your particular workforce, the goals of your plan, and company cash flow when designing your company retirement plan.

A year-end true-up is a process that ensures employees receive their full employer matching contributions. Some people think it’s great! I’ll define it for you, give some examples, and then outline some pitfalls so you can see how at first it sounds great on the surface…and what is lurking below the surface.

Employees make contributions: Throughout the year, employees make regular contributions to their retirement accounts (401(k), 403(b), etc.) from their paychecks. Employees are allowed to start, stop, or change their contributions, per their particular plan rules.

Employer makes matching contributions: Many employers offer a matching contribution as part of their retirement plan – research shows it increases participation, among other things. The employer matches a percentage of the employee's contributions, up to a certain limit. These contributions are often made per paycheck but can be made using different timing, such as quarterly or annually. Which leads us to…

The plan document: The plan document stipulates the timing of the matching calculation and what compensation it’s calculated using. For example, it may not include compensation from when an employee wasn’t eligible for the plan for part of the year. Matching may not be made on auto allowance, catch-up contributions, bonuses, or other types of pay. The match may be calculated per paycheck, or it may be calculated on the entire year’s pay and has a true up.

What happens at the Year-End True-Up: To ensure that employees receive their full employer matching contributions, some employers perform a year-end true-up calculation. This calculation compares the total amount the employee would have received in matching contributions if they had contributed evenly throughout the year to the actual amount they received based on their contributions.

True-Up Contribution: If the true-up calculation reveals that an employee missed out on matching contributions, the employer will make an additional contribution to the employee's 401(k) account to make up for the difference. This true-up contribution is typically made after the end of the calendar year but before the tax filing deadline for that year.

It's important to note that the specific rules and procedures for year-end true-ups can vary between different employers and 401(k) plans. Check your employer's 401(k) plan documents or speak with your HR department or plan administrator for the details of your plan.

NOW for Example 1

Cheryl makes $100,000 per year and is paid 26 times per year.

The match is 4% structured this way: 100% up to 3% and 50% on the next 2% (She needs to contribute 5% to receive the full 4% match.)

Cheryl signs up and contributes 5% to her 401(k). 

For 26 paychecks, she contributes $192.30.

She receives $153.85 in match each paycheck.

At year-end, she has contributed $5000 and her employer has contributed $4000. No true-up contribution is needed.

Example 2 

Ricardo makes $100,000 and is paid 26 times per year. 

Ricardo contributes 10% to his 401k for awhile and then stops contributing for the rest of the year.

For 12 paychecks, he contributes $833.33/pay.

He receives $153.84 in match for those 12 paychecks, then zero because he stops contributing.

Year-end totals: he has contributed $5,000 and received $1,846.15 in match.

-- BUT $100,000 / $5000 = 5% so he should get the full 4% match! --

The true-up is performed and he receives an additional $2,153.85 so that he gets the full employer match.

*If his plan only matched per paycheck and did NOT base it on annual pay with a true-up, he would be stuck only getting $1,846.15 in matching.*

Example 3

Remember that the IRS sets a maximum annual contribution limit for 401(k) plans. For 2023, the limit is $22,500 for individuals under 50 years of age and $30,000 for individuals who are turning 50 or older (including the catch-up contribution). 

Bill contributes to the plan and hits the IRS Contribution Limit by September. Since he reached the annual contribution limit, his contributions to the 401(k) plan stop. The match was deposited per payroll and those stopped as well when his contributions stopped.

Bill will then miss out on the employer matching contributions for the remaining pay periods — unless the plan has a true-up.

And now for the Blind Spots

Surprise! It’s year-end and you owe money! No one likes this. Budgetary constraints may make these types of year-end surprise contributions painful. Matching per pay can be easier for business cashflow. Don’t forget those last-minute holiday bonuses or spot bonuses, especially if your plan matches on “All W2 Compensation.” This can create more work at year-end, so be early on submitting your census to your administrator/recordkeeper.

You might be punishing certain employees if you don’t perform the true-up. Take a look at who traditionally maxes out early or who changes their contributions throughout the year. Make sure you let the workforce know if you’re NOT doing a true-up for the plan to avoid angry knocks on HR’s door.

If you have high turnover and/or employees leave throughout the year and they will get a true-up, you’re going to need to reopen any accounts that left the plan to deposit the true-up. Again, communication strategy is key. You’ll want to communicate to terminating employees to consider waiting until April or whenever you’ll be making the deposit before they take their money or they may have two distribution fees they’ll have to pay.

In conclusion, this leads us back to where we started. 

It’s really important to have a good team on your side to help you run your retirement plan. The devil is indeed in the details! What sounds like a good idea on the surface can be a costly, giant pain later if you’re not considering the right things when making decisions and communicating plan provisions well. If you’re tired of surprises caused by working with an advisor that isn’t well-versed in retirement plans and lacks the creative problem-solving capability you need, please reach out or include us in your next advisor search!