What Is Contract Retention in Construction?
Contract retention, also called retainage, is the portion of a contractor’s payment that an owner withholds until agreed-upon project milestones are met. The typical range is 5% to 10% of the contract value, and it can run slightly higher for subcontractors. Retention gives owners a financial guarantee that work will be finished to specification, and it shapes cash flow for every party on the job.
The purpose of contract retention — also known as retainage — is to incentivize contractors to complete a job according to the contract terms by withholding a portion of their payment until all agreed-upon project milestones have been met. It’s a risk management mechanism that ties final payment to work that has been completed and accepted.
Why Do Owners Withhold Retention?
Owners withhold retention for one reason: it keeps a financial incentive on the table until the work is finished and accepted.
The practice started in the mid-1800s in the U.K., and has continued in the U.S. for more than 100 years as a way to guarantee certain outcomes, including:
- As extra insurance for owners that the job will be done.
- To guarantee work will pass quality control requirements, not only meeting workmanship standards, but that the materials aren’t inferior to what the owner expected.
- As a form of protection for owners against work that isn’t completed to their project requirements.
But contract retention serves more than just project owners’ needs. Contractors are often a part of negotiating the retention plan in the early stages of the contract to ensure realistic expectations for the project, set up payment terms and protect their own profit margins.
Who Holds Retention on a Construction Project?
Two levels of retention are often in play on a project:
- Owners build a retention clause into the construction contract that withholds a certain percentage of the monies owed to the contractor until the job is completed and verified free of flaws. So, if the contractor doesn’t complete the project or correct any mistakes, they forfeit the retention money.
- Likewise, contractors often have a retention policy with their own subcontractors and suppliers to guarantee that the work — which the contractor is ultimately responsible for — is accomplished according to spec.
How Much Retention Is Withheld, and Who Regulates It?
This practice is unique to the industry and is so ingrained in construction culture that it’s regulated in the U.S. by the federal government as well as in each of the 50 states for public works projects. And in all states except New Mexico, private or commercial project contracts are also allowed to include retention clauses.
The typical range for contract retention for a contractor can vary by state and is largely determined by the owner and contractor per project. It hovers between 5-10% and can skew slightly higher for subcontractors. Federal and state projects typically have a lower rate than private projects. As a percentage, it may not sound like much at first. After all, the contractor is still getting 90-95% of their fee. But translate that percentage into hard dollars and it takes on a different outcome. It can amount to a substantial chunk of money, even more so when it’s for a sizable project like a hospital, commercial building or power plant. And it is likely the contractor will be using much of that retained portion to pay for subcontractor wages and other project-related expenses, making timely remittance even more impactful.
As far as private projects go, there are legal limits to how much retention a project owner can withhold, for how long and how it’s paid out. But again, they are state-specific and don’t have the kind of protections in place like government projects do. However, states may impose interest penalties if an owner misuses the retention money.
What Makes Contract Retention Hard to Manage?
While the benefits may make sense from a risk management perspective, the practice has some inherent challenges, such as:
- Effectively tracking who is subject to retention, how much and when to pay them can be difficult to manage. This is because sifting through and accurately calculating the dozens or even hundreds of retention-contingent invoices on a regular basis can be a rather lengthy process when done by hand or computer spreadsheet, as is often the case in construction, and especially so for larger projects.
- It can take months for contractors to receive retention pay. For their subcontractors, it could be much longer than that if their portion of the project is finished before the contractor’s is. The reason being that many contracts stipulate that retention won’t be paid until the entire capital project is done, which includes the quality assurance/defect liability phase to check for any flaws in the work.
- Withholding pay from contractors can create a cash flow problem for tight-margin projects, especially if the margin is less than the retention percentage. This may affect their ability to pay subcontractors while also footing the bill for equipment and materials necessary for the job. A contractor’s reputation may suffer if they’re unable to pay subcontractors due to the retention money being withheld.
What to Look for in a System That Tracks Retention
Retention tracking tends to fail in the same few places, so it’s worth checking any system against those specifically rather than against a feature list:
- Retention is held the way your contract reads. Some contracts set a flat percentage for the life of the job, others step the rate down after substantial completion, and others release by milestone. If a system only supports one flat rate, someone will be working around it in a spreadsheet within a month.
- A link between each retained amount and the pay application it came from, so you can trace a balance back to the work it relates to instead of reconstructing it at closeout.
- Visibility in both directions down the subcontract chain. If you’re holding retention from subcontractors while an owner holds retention from you, you need both positions in one view, not two.
- Release conditions tied to schedule milestones rather than calendar reminders, so the trigger is a project event you can see coming.
- An audit trail of what was agreed and when. Retention disputes surface months after the work is done, and they’re almost always arguments about the record.
InEight Contract covers this ground as part of InEight Project Controls. It tracks your contract development, payment obligations, and subcontractor workflows in one place, so you can see project progress measured against the contract conditions it has to satisfy.
Retention also sits downstream of how you bill progress in the first place. On time-and-materials and cost-plus work, the records that justify a retention release are the same ones that have to survive an audit, which is why billing audit readiness and retention tracking tend to be the same problem seen from two ends of the same job.
