What Is a 401(k) True-Up and How Does It Work?

A 401(k) plan serves as a widely utilized retirement savings vehicle, offering individuals a structured way to accumulate funds for their future. A significant aspect of many such plans involves contributions made by employers, particularly through matching programs. These employer contributions can substantially boost an employee’s retirement savings, supplementing their own deferrals. To ensure employees receive their full entitled match, specific reconciliation procedures are in place. These procedures address various scenarios that might otherwise lead to an incomplete employer match.

Foundations of 401(k) Employer Matching

Employer matching contributions in 401(k) plans are designed to encourage employees to save for retirement by providing an additional incentive. A common matching formula might involve the employer contributing 50 cents for every dollar an employee defers, up to a certain percentage of the employee’s salary, such as the first 6%. This means if an employee contributes 6% of their pay, the employer would contribute an amount equal to 3% of their pay.

The method by which these matching contributions are calculated and applied throughout the year can vary significantly. Some plans calculate and provide the employer match on a “per-pay-period” basis. Under this approach, the employer’s match is determined and added to the employee’s account with each payroll cycle, based on the employee’s contributions during that specific period.

A per-pay-period matching approach can sometimes result in employees missing out on a portion of their potential full match over the course of a year. For instance, if an employee front-loads their contributions and reaches the annual Internal Revenue Service (IRS) deferral limit early in the year, they might stop contributing to their 401(k) for the remaining pay periods. Consequently, they would not receive any further per-pay-period employer matches for the rest of the year, even though their annual contributions might qualify for a larger overall match under the plan’s design. This scenario, alongside others like mid-year salary changes or uneven contribution patterns, highlights a common challenge in maximizing the employer benefit.

Defining a 401(k) True-Up

A 401(k) true-up is a specific reconciliation process performed by employers to ensure that plan participants receive the full employer matching contribution they are entitled to based on the plan’s annual matching formula. This process accounts for various factors that might cause an employee to receive less than their full potential match if only per-pay-period calculations were used. The true-up mechanism addresses the disparity between the cumulative per-pay-period matches an employee received and the total match they would have been eligible for based on their entire year’s compensation and contributions.

The necessity for a true-up arises directly from scenarios where an employee’s contribution pattern throughout the year does not perfectly align with the per-pay-period matching structure. For example, an employee who maximizes their 401(k) contributions early in the year might stop deferring later on, thereby missing out on matching contributions for subsequent pay periods. Similarly, employees experiencing salary increases or changes in their contribution rates mid-year could also be affected. The true-up process ensures fairness and maximizes the benefit for employees by making up any difference. It guarantees that the total employer match received by the employee at year-end accurately reflects what they would have earned if the matching calculation had been based on their entire annual compensation and total contributions, rather than being limited by individual pay period contributions.

Calculating True-Up Contributions

The calculation of a true-up contribution involves a systematic review of an employee’s annual 401(k) activity. The employer or their designated plan administrator compiles the employee’s total eligible compensation for the entire plan year. Simultaneously, they gather the sum of all the employee’s 401(k) deferrals made throughout that same year. Next, the plan’s annual matching formula is applied to these annual figures to determine the total employer matching contribution that would be owed to the employee for the entire year.

For instance, if a plan matches 50% of the first 6% of an employee’s annual salary, and the employee earns $100,000 and contributes at least $6,000, the total potential annual match would be $3,000. This calculated total annual match is then compared against the aggregate amount of matching contributions the employee has already received on a per-pay-period basis throughout the year. If the total annual match owed exceeds the sum of the per-pay-period matches already disbursed, the difference represents the true-up contribution. This additional amount is then deposited into the employee’s 401(k) account to ensure they receive their full entitlement. For example, if the annual potential match is $3,000 but the employee only received $1,500 through per-pay-period matches, the true-up contribution would be $1,500.

Administrative Aspects and Employee Impact

True-up contributions are typically processed periodically, with the most common timing being at year-end, following the close of the plan’s fiscal year. Some plan designs may opt for more frequent true-ups, such as quarterly or semi-annually, depending on the employer’s preference and administrative capabilities. The inclusion of a true-up provision is a specific design choice made by the employer and is not a universal requirement for all 401(k) plans.

The administrative responsibility for performing the true-up calculation and disbursing the contributions rests with the employer or their third-party administrator (TPA). These entities have access to the necessary payroll and contribution data to accurately assess each employee’s eligibility and determine any additional amounts owed. The process requires careful reconciliation to ensure compliance with plan documents and regulatory guidelines.

For employees, the impact of a true-up is generally positive, often resulting in an unexpected additional contribution to their 401(k) account. While employees may not always be explicitly notified of the true-up calculation itself, they typically observe an additional deposit labeled as an employer contribution or similar on their 401(k) statement. This additional match further enhances their retirement savings.