Retainage

What is Retainage in Construction?

In construction projects, retainage refers to the portion of payments that project owners or general contractors withhold from contractors or subcontractors. This practice ensures contractors meet contractual obligations and complete the project to agreed-upon standards. By “retaining” a percentage of each payment, owners maintain leverage to address quality issues, incomplete work, or disputes before releasing the full payment.

Retainage is common in large commercial and public construction projects, where accountability and risk management are critical. Typically, owners or general contractors will specify the retainage percentage in the contract—usually around 5% or 10%. According to terms outlined in the contract, withheld funds are only released after meeting specific conditions, such as completing inspections, addressing punch lists, or obtaining lien waivers.

Retainage Laws

For a given project, retainage practices are subject to federal and/or state regulations, which are designed to ensure fairness and prevent abuse.

Federal Retainage Laws

Federally funded construction projects—i.e., those funded by federal agencies, such as the Department of Transportation, the Department of Defense, etc.—are governed by the regulations outlined in the Federal Acquisition Regulation (FAR). FAR serves as the primary set of rules and guidelines for the acquisition of goods and services by federal agencies, including construction projects and their payment practices. Several aspects of retainage are explicitly addressed within FAR, including:

• Retainage Percentage – According to FAR, the Government may withhold up to 10% of progress payments if the Contracting Officer determines that satisfactory progress has not been achieved. However, for work deemed substantially complete or distinct project phases that are finalized, payments may be made without additional retainage.
• Progress Payments – FAR mandates that progress payments be made monthly or more frequently based on approved estimates of completed work. Contractors are required to provide detailed substantiation, including itemized progress, subcontractor payment statuses, and other supporting data.
• Conditions for Retainage Release – Retainage may only be released after substantial completion, final inspections, acceptance of work, and resolution of claims. The regulation specifies that retained funds remain withheld until the Contracting Officer confirms that these conditions have been satisfied.
• Certified Requests – FAR requires contractors to submit certified payment requests that confirm compliance with contractual terms, including proper allocation of payments to subcontractors and suppliers.

State Retainage Laws

State retainage laws govern projects funded within their jurisdictions and typically distinguish between state-funded public projects and privately funded projects. Public projects often have stricter regulations to ensure accountability for taxpayer funds, while private projects allow more flexibility but must still comply with overarching state laws.

• Retainage Caps – For state-funded projects, retainage is often capped to protect contractor cash flow while maintaining owner security. States like Texas allow up to 10% retainage, while New York, Alabama, and Washington cap retainage for public projects at 5%. In New Mexico, retainage is prohibited for publicly funded projects. On private projects, caps are generally negotiable unless otherwise specified by state law.
• Timelines for Retainage Release – Most state laws define specific deadlines for releasing retainage on state-funded projects. California mandates release within 60 days of substantial completion, while Florida requires release within 30 days of final acceptance. Private projects may follow similar timelines if outlined in the contract.
• Escrow Requirements – States like Massachusetts and Michigan require retainage for state-funded public projects to be held in interest-bearing escrow accounts, providing additional security for contractors. This requirement does not typically extend to private projects.
• Prompt Payment Acts – For both state-funded and private projects, laws in states such as New York and Maryland enforce penalties for late retainage payments. These acts often include provisions requiring general contractors to promptly release retainage to subcontractors after receiving it from the project owner.

While public projects tend to be more tightly regulated, contractors must carefully review state retainage laws and contract terms to ensure compliance, especially when operating across multiple jurisdictions.

Relationship Between State and Federal Retainage Laws

The relationship between federal and state retainage laws depends on the source of project funding. For federally funded projects, the Federal Acquisition Regulation (FAR) takes precedence, dictating retainage practices such as caps, progress payment schedules, and conditions for release. In these cases, state laws only apply in areas where FAR is silent, such as specific subcontractor protections.

For state-funded public projects and privately funded projects, state retainage laws govern retainage practices entirely. These laws may include requirements for caps, timelines, and escrow accounts that go beyond federal guidelines. Contractors working on projects funded jointly by federal and state sources must navigate overlapping regulations, often following the stricter of the two to ensure compliance.

When operating across multiple jurisdictions or on complex projects, contractors should work closely with project owners and legal advisors to confirm which laws apply and how to address potential conflicts. Typically, the requirements and terms that govern the project will be explicitly outlined in the project’s contract.

Retainage in Construction Contracts

Retainage terms in construction contracts define how funds are withheld and released, ensuring alignment with project milestones and compliance standards. These terms typically address several key components:

Retention Percentages

Contracts specify the portion of each payment withheld as retainage, often 5% to 10%, depending on the project and jurisdiction. Public projects adhere to federal- or state-mandated caps, while private contracts allow for negotiated terms.

Conditions for Release

Retainage is released after contractors meet defined milestones, including:

• Achieving substantial completion when the project can be used as intended.
• Addressing punch list items, such as minor defects or incomplete work.
• Passing final inspections and confirming compliance with project specifications.
• Submitting lien waivers and verifying that all payments for labor and materials are resolved.
• Confirming subcontractor payments, as required in some contracts.

Common Retainage Contract Terms

Beyond these essentials, contracts often include provisions to address cash flow and flexibility:

• Tiered Retainage Reductions – Retainage percentages may decrease as the project nears completion.
• Partial Retainage Release for Subcontractors – Subcontractors may receive retained funds after completing their portion of the work, even if the larger project continues.
• Escrow Accounts and Retainage Bonds – Public projects may require retainage to be held in escrow accounts, while private contracts sometimes allow retainage bonds as an alternative.

Retainage terms vary depending on the project type and jurisdiction, and contractors should review them closely to understand their obligations and payment schedules.

Sample Retainage Clause

Here is a sample of a retainage clause that might appear in a construction contract. Keep in mind that retainage laws vary by state and jurisdiction, so it is important to tailor the language to comply with local regulations.

Download Sample Retainage Clause (PDF, Google Document, Microsoft Word)

Disclaimer: This sample retainage clause is provided for informational purposes only and should not be construed as legal advice. Construction contracts are subject to varying laws and regulations depending on jurisdiction and project type. Users are strongly advised to consult with a qualified attorney or legal professional to ensure compliance with applicable laws and to tailor contract terms to their specific needs. Construction Coverage assumes no liability for the use or misuse of this sample clause.

Retainage Example

To better understand how retainage works in practice, consider a $5 million commercial construction project where a general contractor (GC) is hired to oversee the construction of an office building. The project owner and GC agree to a 10% retainage clause in the contract, meaning 10% of every progress payment will be withheld until specific conditions are met.

The GC submits monthly invoices to the project owner for work completed. For example, in the first month, the GC invoices the owner for $500,000 worth of completed work. However, with retainage applied, the owner withholds $50,000 and pays the GC $450,000. This process repeats each month as progress payments are made, and by the end of the project, the owner has withheld a total of $500,000 in retainage. These funds provide the owner with financial security, ensuring that all contractual obligations are met before the full payment is released.

The GC, in turn, applies a similar 10% retainage to payments made to subcontractors. For instance, a plumbing subcontractor might invoice the GC for $100,000 in the first month. The GC withholds $10,000 and pays the subcontractor $90,000, creating a cascading effect. This ensures subcontractors fulfill their commitments, but it also delays cash flow across the construction hierarchy.

Once the project is substantially complete, the owner conducts final inspections and verifies that the GC has resolved punch list items, submitted lien waivers, and met all other contract conditions. After approval, the owner releases the full $500,000 retainage to the GC. The GC then disburses the subcontractors’ retainage, provided they’ve met their obligations.

For larger projects or phased completions, retainage may be released in stages. For example, the plumbing subcontractor’s retainage could be released upon completing and inspecting their portion of the work, even if the rest of the building is still under construction. This flexibility helps mitigate cash flow pressures while maintaining accountability.

Although retainage provides necessary financial protection for project owners, it can strain cash flow for contractors and subcontractors. Both parties must carefully manage their finances to handle delayed payments and plan for retainage release timelines.

Accounting for Retainage

Retainage is tracked as either a liability or an asset, depending on whether it is withheld from subcontractors or retained by the project owner.

• Retainage Payable – These are funds withheld by a contractor from payments to subcontractors. They are recorded as a liability in the contractor’s ledger until the funds are released.
• Retainage Receivable – These are funds withheld from the contractor by the project owner. They are recorded as an asset on the contractor’s balance sheet but are not recognized as revenue until the retainage is paid out.

These amounts are not recognized as revenue until the retainage is released, and managing these balances effectively can be challenging—especially for large projects, multiple projects, or projects spanning multiple jurisdictions with varying retainage laws.

Accounting for retainage requires precision in tracking and reporting these balances. Most contractors now rely on specialized accounting practices and software to streamline this process. Accounting tools like CMIC and NetSuite automate retainage payable and retainage receivable management, reducing administrative overhead.

Software for Retainage Accounting

Modern construction accounting platforms simplify retainage management by offering specialized features that automate processes, verify compliance, and improve accuracy. Some of the key capabilities of these tools include:

• Retainage Tracking – Many platforms offer tools to monitor retainage balances across projects, helping contractors maintain visibility into withheld amounts. These tools often include dashboards that provide real-time updates on payment statuses, outstanding balances, and upcoming deadlines.
• Automated Retainage Calculations – The calculation of retainage amounts, whether based on fixed percentages, tiered reductions, or specific milestones, is handled seamlessly by accounting software. This ensures consistency with contract terms and reduces manual errors.
• Retainage Billing and Invoicing Tools – Retainage software simplifies the invoicing process by generating retainage-specific invoices or incorporating withheld amounts into standard forms like AIA G702 and G703. These tools also track submission statuses and payment requests, integrating seamlessly with broader accounting workflows to ensure efficiency and compliance.
• Compliance Monitoring – Tools designed to support compliance help contractors track escrow requirements, calculate interest on retained funds, and generate reports for audits or legal needs. These features ensure alignment with state and federal regulations.
• Escrow Account Management – Where retainage laws require escrow accounts, software solutions track both the deposited amounts and accrued interest. Contractors can use this functionality to streamline documentation and meet obligations for retainage release.
• Multi-Project Functionality – For contractors managing numerous projects, retainage features allow adjustments for varying state laws and contract-specific retainage terms. This functionality simplifies oversight across diverse jurisdictions and project types.
• Integration with Job Costing – Many retainage tools integrate with job costing systems, enabling contractors to link withheld amounts to cost codes. This allows for detailed tracking of project costs and a clearer view of how retainage impacts overall budgets and profitability.

Retainage plays a critical role in balancing financial security and contractual obligations in construction projects. Accurate tracking, streamlined processes, and adherence to legal requirements ensure that withheld funds are handled efficiently and fairly. By combining disciplined accounting practices with modern software solutions, contractors can navigate the complexities of retainage while maintaining financial stability and fostering trust with project stakeholders.

References

Federal Acquisition Regulation (FAR)

American Institute of Architects (AIA)