True-up Clause for 401(k) Plan
(Matching Contributions)

Summary

This template is a true-up clause that can be used in a 401(k) plan offering employer matching contributions. When matching on a payroll or monthly basis, 401(k) plans can cause participants to miss out on the plan's maximum employer match. True-up clauses make up for lost employer matching contributions. This template includes practical guidance, drafting notes, and an alternate clause. Many 401(k) plans allocate (and deposit in trust) employer matching contributions on a per-paycheck formula, often even reflecting the amount of the match plan allocation on the employee's paystub. For example, a matching provision indicating "the definition of Pay shall apply separately for each payroll period." Is not uncommon. However, this can cause a participating employee to miss out on matching contributions. A typical 401(k) matching formula is one where an employer matching contribution equals 50% of the participant's paycheck contribution (referencing the plan's definition of plan (benefits-bearing) compensation) up to a maximum match of x% of the eligible employee-participant's plan compensation for that pay period. We'll use 6% for this example. With this particular design, so long as an eligible employee contributes at least 6% of the employee's compensation consistently, paycheck-to-paycheck, the maximum employer matching contribution will be achieved, on an annual basis, which should equal 3% of the participant's plan compensation (ignoring increases in pay). However, if the plan includes a true-up provision, the plan administrator will review the participant's total annual contributions and be sure that the maximum permissible employer matching contributions has been made, referencing the participant's contributions and compensation for the entire plan year. A common occasion that the true-up helps maximize the employee's total plan contributions is where an eligible employee defers below the maximum match threshold for some pay periods and above that threshold in other pay periods. So, allowing the true-up can benefit participants who change their deferral percentage through the plan year, particularly where they chose to reduce their deferral rate for any part of the year, so they did not, for those pay periods, receive any or even less than the maximum, matching contribution allocation. With a true-up clause, each participant's annual deferral amount is divided by his or her annual compensation. So, if a participant chooses to defer 12% for the first half of the year and 0% for the other half, this yields an annual deferral rate of 6%. If the plan provided a 6% match, without the true-up clause, the participant would receive a 6% match only for the contributions made in the first half of the year. With the true up clause, the annual deferral is 6%, and the entire annual amount deferred is eligible for a matching at the 6% rate, doubling the match the participant otherwise would have been allocated. The rue-up allocation is limited to that difference. Illustration: • Plan A, which is non-safe harbor 401(k) plan, matches the first 6% of an eligible employee's pre-tax/Roth contributions to the plan. • Participant B's annual base compensation in the plan year beginning January 1, 2022 is $120,000 (paid $10,000 monthly on a gross basis). She has set her contribution rate to 12%. Participant A is 45 years old. The Section 402(g) limit for 2022 is $20,500. • Plan A allows pre-tax/Roth contributions by eligible employees with reference to their base compensation and cash bonus, matching those amounts at a 6% rate. Participant B received a cash bonus of $80,000 in February 2022. • By March 2022, Participant B has received $100,000 of plan compensation, contributed $12,000 in pre-tax/Roth contributions, which the plan matched at a 6% rate, allocating $6,000 to her plan account. If Participant B continues to contribute 12% of her annual compensation, she will reach the Section 402(g) limit of $20,500 in her first October paycheck. Under the terms of the plan (in compliance with I.R.C. § 401(a)(30)) her pre-tax/Roth contributions must cease at that time even though the plan (without the Section 402(g) limit applying) would have allowed a matching contribution of 6% on the full amount of her $200,00 plan compensation (for a $12,000 total match, ignoring any issues related to nondiscrimination testing under Section 401(k)(3) and (m)(2)). • Because the plan includes a true-up provision, following the end of the plan year, the plan administrator calculates that a true up of $1,794 is due to Employee A's account so that, on an annual basis, she receives the maximum matching contribution allocation of $12,000 ($200,000 total plan compensation times 6%). For this purpose, the plan assumes she would have contributed 6% of her plan compensation for the remaining months of the plan year. Note that the true-up clause requires that the employee continues to be employed (i.e., she continues to be an eligible employee on the last day of the plan year. A true-up can be designed to address several situations. • With a true-up provision, an employee who joins the plan midyear can get up to the maximum employer matching contribution allocation the employee would have received had the employee joined the plan on the first day of the plan year. This will require the employee to set their contribution rate greater (twice as great to obtain the fullest match) than the maximum employer matching percentage. • Per the illustration above, a true-up provision allows an employee who makes smaller contributions at the beginning of the year, missing out on the maximum matching contributions permitted under the plan, to achieve up to the maximum employer matching contribution allocation under the plan where the employee increases their contribution percentage during the year (or vice versa). • A true-up provision allows an employee who meets the I.R.C. Section 402(g) limit for the year before year-end, at which the plan should cease to allow pre-tax/Roth contributions (outside of permissible catch-up contributions), to still receive a make-up allocation for the missed matching contributions on those precluded contributions. Note, this may also be handled in a nonqualified deferred compensation plan, but not all employees who reach the Section 402(g) limit may meet the requirement for a top-hat plan that it be established "primarily for the purpose of providing deferred compensation for a select group of management or highly compensated employees." ERISA Sections 201(2), 301(a)(3) and 401(a)(1) (29 U.S.C. 1051(2), 1081(a)(3), 1101(a)(1)). For a further discussion of nonqualified deferred compensation plans, see ARTICLE: The Practice and Tax Consequences of Nonqualified Deferred Compensation, 75 Wash & Lee L. Rev. 2065. Also see 401(k) Plans: Understanding the Rules, Qualified Retirement Plan Fundamentals, Safe Harbor 401(k) Plan Design and Administration, and True-Up Clause for 401(k) Plan (Matching Contributions) (Summary Plan Description).