What are they and why do we have to true-up?
True-up contributions may be required when the Plan document specifies that the match is to be determined on an annualized basis, but the match had been calculated and deposited each pay period. They typically occur when a participant defers above the maximum match threshold for some pay periods and below the threshold in other pay periods.
For example, a participant has an annual salary of $60,000 paid monthly and contributes 8% per paycheck for the first six months of the year. They then reduce their contributions to 0% for the last 6 months of the year. Their employer’s 401(k) Plan has an employer match formula of 100% of contributions up to 4% of compensation.
$60,000 annual salary or $5,000 per month
Employee deferral: $5,000 X 8% = $400 deferral per month
Employer contribution: $5,000 X 4% = $200 match per month
With a pay period match, the match formula is applied to the deferral and compensation amounts from each individual pay period. In this example, in the first half of the year the participant was deferring 8%. As only deferrals up to 4% are matched, the participant does not receive a match on any deferrals over that set limit. The annual employer match amount is simply the sum of the matching contributions which were calculated for each individual pay period.
$400 monthly employee deferral x 6 months = $2,400
$200 monthly employer match X 6 months = $1,200
When calculating the employer match over the full Plan year, each participant’s annual deferral amount is divided by their annual compensation to calculate the annual deferral rate. In the example above, the participant deferred 8% for the first six months and 0% for the last six months, resulting in an annual deferral rate of 4%. Unlike the per pay period calculation where a portion of the deferrals were not matched because they exceed the formula, when calculating the match over the full Plan year, the entire amount of deferrals are eligible for the match.
Total employee deferral for the year $2,400 / $60,000 annual salary = 4% annual deferral rate
It is very common for companies to calculate and deposit their employer matching contributions each pay period. Payroll providers should be able to easily calculate the matching contributions per pay period. This would ease the cash flow to make smaller deposits per pay period over the course of the Plan year compared to one large deposit after year-end. If the Plan documents dictate for a Plan year match, it may still be possible to calculate per pay period, and true-ups may be needed at the end of the year. Looking at the example above, if the employer match is calculated per pay period, and the Plan documents state for a Plan year match, this participant would be entitled to a $1,200 true-up match after the end of the year (the difference between the $2,400 Plan year match calculated and the $1,200 that was funded throughout the year).
If you are considering amending your Plan to change the calculation method from Plan year to per pay period to eliminate match true-ups, you may want to review who receives most of the true-up contributions. Some employees will defer 100% of a single paycheck to max out their deferrals for the year rather than spreading them out throughout the year. In this instance, a pay period match would result in no true-up, and it is the employee who loses out on receiving the full company match. Sticking with a Plan year match assures they receive the full annual match.