What is a True-Up Contribution?
What is a True-Up Contribution?
If you're a participant or sponsor of a 401(k) plan, you may have heard of "true-up" contributions. But what are these contributions, and why are they important?
True-up contributions are a way for employers to ensure that all eligible employees receive the full employer matching contribution for the year, even if they contributed less evenly throughout the year or maxed out their contributions early in the year.
Example
Here's an example of when this would come into play. An employee gets a 6% match and makes $100,000. So 6% of the employee's income would amount to $6,000 in employer matching contributions. That employee wants to maximize their 2023 contributions by contributing $22,500. If there are 26 pay periods, that would be about $865.38 in employee deferrals and $230.77 in employer matches per pay period ($6,000 annually).
If this employee doubled their contributions, they would reach the IRS contribution limit in half the time. However, once they reach that $22,500 employee contribution limit, they will no longer receive a match since they can no longer contribute. Therefore, they would only be entitled to $3,000 in total employer match if unable to contribute.
That's where true-up contributions come in. At the plan year's end, the employer will look at total contributions and determine if employees are eligible for additional matching contributions. If participants contributed more in some pay periods to receive the full match, you would make a true-up contribution to make up the difference. In the case of the example above, the employer would provide an additional $3,000, so the employee would receive a total of $6,000 in contributions.
Conclusion
True-up contributions can be a valuable benefit for employees, especially those who may not be able to contribute evenly throughout the year due to changes in their financial situation or other factors. In addition, by ensuring that all eligible employees receive the full matching contribution, employers can help their employees save more for retirement. However, not all retirement plans have a true-up provision. Read your plan documents and discuss plan design options with your advisor and TPA to understand all the benefits and drawbacks of true-up contributions.