A 401(k) true-up is an end-of-year calculation that some employers use to make sure that they have contributed everything they owe to an employee’s retirement plan. True ups occur in retirement plans with matching contribution benefits. If your employer offers matching contributions and does not contribute as much to your retirement account as they owe, they make up the difference at the end of the year. Here’s how it works.
A financial advisor who serves your area can help you manage your tax-advantaged plans.
How Do Matching Contributions Work?
When employers offer retirement benefits, they will sometimes offer what is called a matching contribution. This is a promise that your employer will contribute $1 to your retirement account for every $1 that you do, up to the plan’s limit. This is most common with 401(k) and 403(b) plans.
Typically, an employer will structure their contribution limit as a percentage of your income.
For example, your employer might match contributions up to 5% of your income. This means that if you contribute 5% of your income to your 401(k) plan your employer will match that, for a total contribution equal to 10% worth of your income. If you contribute 7% of your income your employer will still contribute an amount worth 5% of your income, for a total equal to 12% worth of your income (your 7% plus the 5% maximum that they contribute).
How Matching Contributions Can Fall Behind
There are typically two ways that an employer will calculate matching contributions: by pay period and by year.
With pay period calculations, your employer calculates their matching contributions based on how much you contribute each pay period. For example, if you make $300 in qualified 401(k) contributions from a given paycheck they will owe your retirement account $300.
With annualized calculations, your employer calculates their matching contributions based on how much you contribute each year. For example, if you make $3,600 in qualified 401(k) contributions over the course of a given year, they will owe your retirement account $3,600.
Even when an employer calculates their matching contributions annually they often process those contributions each pay period. Rather than make a lump-sum contribution at the end of the year, they make matching contributions with each paycheck. This is typically easier and more cost-effective. But if you make irregular or exceptionally large retirement contributions it can lead to a mismatch between what an employer owes and what they contributed.
This happens most often in two cases:
If an employee hits their annual 401(k) contribution limit, they will stop making contributions to their retirement plan partway through the year. This can mean the employer owes the employee for a full year’s retirement contributions. But the employer only processed and paid those matching contributions for part of the year.
If an employee makes occasional, outsized contributions, it can cause an employer to similarly owe more than they have paid. For example, if an employee makes very few but very large, contributions to their retirement account, an employer can wind up owing more than they matched.
Matching Contributions Example
Here’s how the calculation mismatch can occur.
Say that Alex earns $72,000 per year, paid monthly at $6,000 per pay period. His employer offers a 401(k) plan with annual matching contributions of up to 5%. This means that the company will match Alex’s contributions to his 401(k) account up to 5% of his salary (here, $72,000).
At a 5% match per year, this means that Alex’s employer will match his contributions up to $3,600 (0.05 x $72,000) annually. However, they process his contributions with each pay period, meaning that for any given paycheck they will make a matching contribution up to $300 (5% of a $6,000 paycheck).
Ordinarily, this system works as follows:
- Each pay period Alex contributes $300 to his 401(k) plan
- Each pay period Alex’s employer matches that $300 contribution
- After 12 pay periods, cumulatively Alex and his employer have both contributed $3,600 to his 401(k)
However this year Alex decides to accelerate his retirement savings. He contributes $3,000 per month to his 401(k) plan. With a $20,500 contribution limit, Alex can only make 401(k) contributions until July. His contributions would then go as follows:
- Each pay period Alex contributes $3,000 to his 401(k) plan
- Each pay period Alex’s employer matches that contribution up to 5% of his income, so they contribute $300
- After seven months, Alex hits his annual contribution limit and stops putting money into his 401(k). He has contributed $20,500 and his employer has contributed $2,100
Alex only contributed to his 401(k) in seven pay periods. So Alex’s employer only matched his contributions in those seven pay periods. But since he contributed at least 5% of his annual salary, they owe his 401(k) a $3,600 total contribution. This creates a shortfall.
Irregular Contribution Example
To see how irregular contributions might work, take our same example.
Alex makes $6,000 per paycheck with a 5% matching plan. Over the course of the year, he contributes nothing to his 401(k) except for every January when he signs over his entire paycheck to his retirement account.
Alex’s employer would only match that contribution up to 5% of the paycheck, or $300. But they owe him matching contributions up to 5% of his salary, or $3,600. Since he contributed $6,000 to his 401(k), Alex’s employer owes him this full amount, creating a $3,300 shortfall.
A 401(k) True-Up Reconciles Mismatched Contributions
A 401(k) true-up is when employers reconcile how much they owe to an employee’s 401(k) plan and how much they have actually contributed. In relatively rare cases this can mean fixing an accounting error. However, in most cases, it means fixing a mismatch that emerges from how retirement contributions are processed.
When a retirement plan promises to make matching contributions on an annual basis, at the end of each year they must ensure that they did so. Note that plans which calculate their contributions on a pay period basis do not have to conduct annual true-ups.
For those plans, your employer only owes you a matching contribution for any given paycheck that you contributed to your retirement account. They would only need to conduct a true-up in case of error, such as if your account didn’t receive a contribution for a given pay period.
A 401(k) true-up occurs with employers that offer matching contribution plans. If they fall behind in their contributions to your retirement account, they will “true-up” the accounts to make up the difference.
Tips for a Financially Successful Retirement
- No matter how close or far you are from retirement, juggling all of your accounts and investments on your own can get difficult. A financial advisor can take a comprehensive look at your finances and help manage your money on your behalf. SmartAsset’s free matching tool matches you with up to three vetted financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- During the retirement planning process, it’s important to think about the retirement tax laws of the state you want to retire in. By minimizing your retirement tax burden, you can maximize the value of your savings in retirement.
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