What is Construction Retainage?
Construction retainage (or retention) is a portion of the agreed-upon contract price deliberately withheld from progress payments. Typically set between 5% and 10%, these funds act as a security deposit for the project owner.
The purpose is twofold: it provides financial leverage to compel the contractor to complete punch list items at the end of the project, and it provides a pool of funds the owner can use to hire a replacement if the original contractor defaults or abandons the job.
Who is Affected by Retainage?
The applicability of retainage cascades down the entire payment chain. Project owners withhold retainage from General Contractors (GCs). In turn, GCs almost universally withhold the identical percentage from their subcontractors.
Because construction operates on tight margins, a 10% retainage withholding often exceeds the subcontractor's entire profit margin for the job. This means contractors are effectively financing the construction out of pocket until the final release is authorized months or years later.
Legal Limitations and Prompt Pay Acts
Due to the severe cash flow burden retainage places on contractors, many states have enacted laws regulating the practice. These regulations establish maximum allowable withholding percentages (often capped at 5% for public projects) and dictate strict timelines for releasing the funds.
State Prompt Pay Acts mandate that once a project reaches 'substantial completion,' the owner must release the retainage within a specific timeframe, usually 30 days. Failure to do so can result in severe interest penalties applied to the withheld funds.
How to Calculate Retainage Withheld
Retainage is calculated dynamically on each progress payment application based on the value of work completed during that billing period.
Formula: Retainage Withheld = Current Work Completed * Retainage Percentage. Payment Due = Current Work Completed - Retainage Withheld.
Example: A contractor completes $50,000 worth of work in month one. The contract stipulates a 10% retainage rate. The owner withholds $5,000 ($50k * 10%). The contractor receives a progress payment of $45,000. If the total contract is $500,000, the final accumulated retainage pool will be $50,000.
The Retainage Release Process
The release of retainage is typically triggered by a milestone known as 'Substantial Completion,' meaning the building is fit for its intended use. At this point, the owner may release the bulk of the retainage, withholding only a small multiple (e.g., 150%) of the value of the remaining 'punch list' items.
Contractors must usually submit final lien waivers, warranties, and as-built drawings before the final payout is authorized. It is critical for contractors to invoice specifically for retainage release; it is rarely paid out automatically.
Frequently asked questions
Can a general contractor withhold more retainage than the owner?
It depends on state law. However, many states require that a GC cannot withhold a higher percentage from a subcontractor than what the owner is withholding from the GC.
What is a 'variable' or 'sliding scale' retainage?
Some contracts use variable retainage to ease cash flow. For example, 10% is withheld until the project is 50% complete, after which no further retainage is withheld, effectively dropping the overall rate to 5% by the end.
Can retainage be replaced with a bond?
Yes. In many jurisdictions, contractors can post a Retainage Bond. The bond guarantees completion to the owner, allowing the contractor to be paid 100% of their invoices without withholding.
Is retainage taxed before or after it is paid?
For tax and accounting purposes, contractors generally recognize the revenue when it is billed, even though the cash receipt of the retainage portion is deferred.