Posted by Maria T. Hurd, CPA, RPA
UPDATED 7/11/19
Tips and Traps of Compensation: Part I – The Trouble with True-Ups or Lack of True-Ups
When 401(k) and 403(b) plans provide that the match contribution is calculated annually, but administratively, the deposit is done on a payroll by payroll basis, it is important for the plan sponsor to understand and budget for an additional contribution that will need to be made at the end of the year, known as a true-up contribution. The concept and the mechanics of a true-up contribution are best explained by demonstrating an extreme situation: the maximum deferral under Internal Revenue Code Section 402(g) is withheld from the first paycheck of the year.
In the example below, if the plan provided for a payroll by payroll, rather than an annual computation, of the employer match, the participant would receive $2,400 rather than $14,000. Payroll-by-payroll computations are beneficial when administrative simplicity and predictable, even contributions are important to the employer, but they also eliminate the ability for employees to contribute unevenly throughout the year as their circumstances permit, including making large contributions out of bonus payments, as illustrated below.
| $1 for $1 up to 5% Match |
$1 for $1 up to 5% Match |
||||||
| Max. Comp. | Deferral | Payroll by Payroll No True-up |
Payroll by Payroll True-up |
||||
| Jan | $ 60,000.00 | $ 19,000.00 | $ 3,000.00 | $ 3,000.00 | |||
| Feb | $ 20,000.00 | ||||||
| Mar | $ 20,000.00 | ||||||
| Apr | $ 20,000.00 | ||||||
| May | $ 20,000.00 | ||||||
| Jun | $ 20,000.00 | ||||||
| Jul | $ 20,000.00 | ||||||
| Aug | $ 20,000.00 | ||||||
| Sep | $ 20,000.00 | ||||||
| Oct | $ 20,000.00 | ||||||
| Nov | $ 20,000.00 | ||||||
| Dec | $ 20,000.00 | ||||||
| True-up | $ 11,000.00 | ||||||
| $ 280,000.00 | $ 19,000.00 | $ 14,000.00 |
If numerous employees defer their entire bonuses, a plan with an annual computation would lead to a substantial true-up contribution to be owed at the end of each year, which could be a significant cost to an unsuspecting employer. But the difference is not always so drastic and so clear. Sometimes employees like to change their deferral percentages to percentages below and above the maximum throughout the year as their situations change. Administratively, each employee would have to be analyzed to ensure that they receive the plan’s contribution formula computed on an annual basis.
| $1 for $1 up to 5% Match |
$1 for $1 up to 5% Match |
||||||
| Max. Comp. | Deferral | Payroll by Payroll No True-up |
Payroll by Payroll True-up |
||||
| Jan | $ 5,000.00 | $ 200.00 | 4% | $ 200.00 | $ 200.00 | ||
| Feb | $ 5,000.00 | $ 200.00 | 4% | $ 200.00 | $ 200.00 | ||
| Mar | $ 5,000.00 | $ 200.00 | 4% | $ 200.00 | $ 200.00 | ||
| Apr | $ 5,000.00 | $ 200.00 | 4% | $ 200.00 | $ 200.00 | ||
| May | $ 5,000.00 | $ 250.00 | 5% | $ 250.00 | $ 250.00 | ||
| Jun | $ 5,000.00 | $ 250.00 | 5% | $ 250.00 | $ 250.00 | ||
| Jul | $ 5,000.00 | $ 250.00 | 5% | $ 250.00 | $ 250.00 | ||
| Aug | $ 5,000.00 | $ 250.00 | 5% | $ 250.00 | $ 250.00 | ||
| Sep | $ 5,000.00 | $ 300.00 | 6% | $ 250.00 | $ 250.00 | ||
| Oct | $ 5,000.00 | $ 300.00 | 6% | $ 250.00 | $ 250.00 | ||
| Nov | $ 5,000.00 | $ 300.00 | 6% | $ 250.00 | $ 250.00 | ||
| Dec | $ 5,000.00 | $ 300.00 | 6% | $ 250.00 | $ 250.00 | ||
| True-up | $ 200.00 | ||||||
| $ 60,000.00 | $ 3,000.00 | $ 2,800.00 | $ 3,000.00 |
As illustrated above, an employee that gradually increases the deferral percentage, from a percentage below the maximum match to a percentage above for an equal number of months, would receive a true-up contribution that would complete the maximum match available to that person for that year.
The same way that beauty is in the eye of the beholder, whether a true-up is a good idea depends on each employer’s goals and limitations, such as: personal and corporate budget, and the administrative capabilities of the company, internal plan personnel, and the type of contract with the plan’s service providers. Sometimes having the benefit of contributing unevenly throughout the year outweighs the detriment of additional administrative and budget burdens, sometimes it doesn’t.
Like Ramon de Campoamor said: “En este mundo traidor, nada es verdad ni mentira, todo es segun el color del cristal con que se mira. Basically, “In this treacherous world, nothing is universally true or false, it all depends on the beholder’s point of view”.
