Retention Money in Construction: What It Is, How It Works, Who It Benefits and Impacts

Those in the construction industry may be familiar with the term retention money, but they may not understand all the implications involved with it.

You may have questions like:

• What is retention money in construction contracts?
• Is retention money necessary?
• How does retention money work?
• Is retention money going to help or hurt me?

We’ll answer these questions and give you details about why retention money in construction is a long-held tradition and how it can be both impactful and beneficial.

• CM Fusion: Helping Track Costs for Efficiency and Profitability
• What Is Retention Money in Construction Contracts?
• 2 Rules of Retention Money in Construction
• Retention in Construction: How It Works
• Who Retention Money in Construction Benefits and Impacts
• Advantages and Disadvantages of Construction Retention Money
• Additional Things to Keep in Mind With Construction Retention
• Use CM Fusion’s Cost Tracking Software to Document and Keep Track of Construction Costs — Including Retention Money

CM Fusion: Helping Track Costs for Efficiency and Profitability

CM Fusion is a …

• Cloud-based
• Easy-to-use; and
• Mobile-ready

… construction management software designed to keep construction teams organized and on the same page.

With features for …

• Document management
• Scheduling
• Time tracking
• Change orders; and
• Cost tracking

… budgeting and keeping track of retention money will be simple and straightforward — whether you’re a general contractor, architect, or home builder.

CM Fusion has the tools to make your construction jobs easier and more manageable.

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What Is Retention Money in Construction Contracts?

Retention money is money set aside that acts as a sort of warranty in case something goes wrong or needs to be fixed after the job is completed.

Retention may also be referred to as retainage.

Even though the terms technically refer to two different things …

• Retainage refers to money held back; and
• Retention refers to the act of withholding the funds

… they are often used interchangeably. In this article, we will use the terms interchangeably, so retention money or retainage both refer to funds set aside to cover costs that may come to light after a job is finished.

Though we use both terms to refer to the same things in this guide, contractors should pay careful attention to the words used in contracts and should be clear on what those particular terms refer to.

What Is the Purpose of Retention Money in Construction Contracts?

Retention money in construction is used for two primary purposes:

1. As protection for the owner to ensure the job is completed. It also ensures problems will be taken care of that arise during construction or for a specified period after construction is complete.
2. As an incentive for the contractor to complete the project as designed and with the quality as defined in the contract.

Why Is Retention Money in Construction Contracts Important?

Retention money is important because it acts as a sort of insurance policy for the owner.

Owners with retention money specified in a contract have the peace of mind that comes with knowing the contractor is going to fully complete the job or risk losing money.

Should an issue arise that keeps the contractor from completing the job (i.e. lawsuits, frozen assets, etc.), retention money can be used to hire another contractor or subcontractors to finish the job.

For the contractor, retention money in construction may become more important during the end stages of the job.

A contractor may decide it’s better to move on to a new project as long as all the progress payments have been paid in full. That way, they can go ahead and invest in the next project, knowing that retention money is available if problems arise with the owner.

2 Rules of Retention Money in Construction

For owners and contractors alike, these two rules of retention are important to understand:

1. How much retention money is to be withheld?
2. How is the retention money paid out?

The contract is the key to understanding these rules and their implications. Owners and general contractors must agree to terms, and contractors and subcontractors must agree to terms particular to their relationship.

Details of the retainage must be spelled out in the contract. Terms agreed upon in the contract dictate the amount or percentage of retention money withheld, as well as how the retention funds are disbursed.

Owners or contractors cannot randomly decide to hold back money. If retainage is not included in the contract, there is no retainage on that job.

Most states have regulations concerning retainage, so it’s important for contractors and owners to understand the specific rules in their state.

#1: The Amount of Retainage to Be Withheld

The amount of retainage withheld is specific to each job, but is usually between 5-10%.

According to a study by Dennis Bausman, retainage may be withheld at the following percentages:

• 7.59% for private jobs
• 5.56% for state jobs; and
• 3.26% for federal jobs

As we’ve mentioned before, the contract is crucial to record what both parties have agreed to. Though the average retainage is somewhere between five and ten percent, parties can agree to any amount as long as it fits within their state’s limitations.

How Is Retention Calculated in Construction?

Retention money in construction is usually calculated using a percentage of the total cost of the project. Depending on the stipulations in the contract, retainage can be fixed or variable.

With a fixed retainage, an agreed-upon percent is held back from each payment. A variable retainage means that the percentage held back may vary based on the stage of the project. For example, an initial 10% retainage may be decreased to 5% after the project is halfway complete.

It’s important to remember that retainage amounts will vary from job to job and from state to state.

#2: The Time Period Retention Is to Be Withheld

This is where it can get sticky — especially for the contractor or subcontractor.

Some of them must wait for a long time before receiving their retainage. And unfortunately, for various reasons, some retainage funds are never paid out. For this reason, contractors and subs should be careful and wise concerning retainage in construction contracts.

According to the same Bausman study referenced above:

• General contractors wait an average of 99 days to receive their retainage.
• Subcontractors — who are usually finished with their work before the general contractor — wait an average of 167 days to receive retainage funds.

As with rule #1, the details on how and when retainage is disbursed depend on what the parties agree to in the contract. Usually, retained money is held until the project is completely finished.

Additionally, state regulations should be considered concerning retainage payouts, and contractors should pay special attention to the wording.

For example:

• In California, retainage must be paid out within 45 days of the “date of completion.”
• In New York, retainage must be paid out within 30 days after “final approval of the work.”

Here you see that “date of completion” and “final approval of the work” refer to two different concepts — and terms can be difficult to define. “Date of completion” may mean a particular date to the contractor, but to the owner, it may mean the date the buyer was satisfied with the work.

As mentioned before, studying the contract and knowing the state regulations and limitations are of utmost importance.

Retention in Construction: How It Works

Instead of sending invoices for retention funds, contractors use a payment application (also known as a pay app or pay application).

Payment applications include more information than you’ll find on a typical invoice. Pay apps may also include:

• Progress reports of completed work
• Subcontractor invoices
• Photos
• Payroll receipts
• Schedules of work to be completed
• And more

Retainage is usually withheld from each progress payment that the contractor accounts for in each payment application.

For example, let’s say you are billing your customer for an initial payment of $15,000 on an $85,000 job. The contract stipulates a 10% retainage. So your payment app will show:

• $85,000 as the total contract amount
• $15,000 payment due
• $1,500 deducted for retainage
• $13,500 total for the payment application

Each job will be unique with its own contract terms. No matter what the stipulations of each contract, the process can be complicated, and keeping up with all the details can be frustrating.

Using construction management software like CM Fusion can help you keep all the details straight. Document management and cost tracking are parts of CM Fusion’s package that track retention payments throughout the lifetime of a project.

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Who Retention Money in Construction Benefits and Impacts

Retention money in construction can be helpful for some, but it can also negatively impact others in significant ways.

Who It Benefits

Retention money in construction contracts can benefit the following parties in various ways:

• Owners benefit by:

  • Incentivizing the contractors to get the job done according to agreed-upon specifications.
  • Retaining funds to be used if a contractor defaults.
  • Earning interest on retainage funds, depending on the contract terms.
• Contractors benefit by incentivizing subcontractors to complete their work well. They can also earn interest if the contract allows.
• Subcontractors also benefit by being incentivized to do their work well and thoroughly. And if a contractor defaults, a subcontractor can receive their retainage from the owner.

Who It Impacts

Negative impacts of retainage are mostly felt by contractors and others further down the line, like subcontractors or material suppliers. Cash flow is usually the issue for these workers because they must still …

• Pay their employees
• Buy materials
• Pay for insurance; and
• Plan financially for new projects

… while they are waiting to receive full payment themselves.

In addition, negative impacts are felt by the following:

• Contractors - If profit margins are low, the retainage can be more than the projected profit. Because of this, contractors may need to withhold higher amounts from subcontractors, which can cause unnecessary relational problems. And if disputes arise about the completion of the work, timetables are drawn out even more, and the chance of legal action increases — further increasing expenses.
• Subcontractors likely feel the hit more than anyone else. Because their work is usually completed first, they have to wait the longest to receive their retainage funds. All the while, they still have to handle the costs of doing business with reduced funds.
• Material suppliers are usually not considered in the construction contract, leaving them no leverage with retention money. Many suppliers may provide supplies up front and wait to receive payment later. They are often the last to receive payment for materials that have already been purchased and installed.

Advantages and Disadvantages of Construction Retention Money

Advantages

Retention money is a good idea because:

• It’s effective. Retainage in construction has a long history and is shown to be one of the best ways to get a job done correctly.
• It offers incentives, so contractors and subcontractors are motivated to do their jobs well and in a timely manner.
• It provides funds that allow an owner to complete the job if a contractor defaults in some way.

Disadvantages

For others, retention money can be a drawback for the following reasons:

• It can cause financial issues for contractors who are waiting on funds while still trying to meet current obligations.

• Parties can be taken advantage of:

  • Discrepancies can arise over what constitutes a “completed job.”
  • Even though most states have regulations in place, some owners may wait to pay out retention funds till the very last minute.
  • Contractors may withhold retention funds from subcontractors at a higher rate than owners are withholding from them.

Additional Things to Keep in Mind With Construction Retention

The construction industry can be complex, and individual construction projects have many moving parts that are often difficult to manage. Add frustrations with retainage to the mix, and you may have a financial and relational storm on your hands.

To avoid those difficulties, consider the following tips when dealing with construction retainage:

1. Be familiar with state and federal retainage laws.
2. Put retainage in an escrow account to earn interest.
3. Be willing to negotiate on the retainage to make it work for everyone involved.
4. Plan ahead for cash flow problems.
5. If necessary, use your lien rights to get paid.

The most important step you can make is to take advantage of construction software that keeps you organized and prepared for any difficulties retention funds may send your way.

30-Day Free Trial

Use CM Fusion’s Cost Tracking Software to Document and Keep Track of Construction Costs — Including Retention Money

In addition to CM Fusion’s cost tracking and document tracking features, contractors use the following features to run their businesses efficiently and productively:

• Scheduling
• Field reports
• Project tasks
• Submittals
• RFIs
• RFPs
• Bidding
• And more

CM Fusion is affordable and easy to use. There’s no need for long training sessions, and you can set up your first project in less than 60 seconds.

And because our software is cloud-based, you can access your account from anywhere the internet is available — on your computer, tablet, or phone.

Try CM Fusion free for 30 days, and you’ll see why countless contractors are turning to us for their construction administration needs.