What is Retention in Construction? Everything You Need to Know

In the world of construction, project success depends not only on completing the work but also ensuring you meet the desired quality standards. This is where the concept of retention comes in.

Essentially retention is a fixed percentage of the total payment due for a contract, withheld from each progress claim and not paid until the project is complete.

It is often included in construction contracts to serve as a financial safeguard, ensuring that the head contractor or subcontractor delivers on their promises and upholds the agreed-upon quality of work.

In this article, we will explore the concept of retention in construction, explain how it works and provide some valuable insights on how to manage its impact to ensure successful project outcomes. Let’s get started!

What is retention in construction?

Retention in construction is a financial security usually held by the principal against the head contractor and by the head contractor against subcontractors.

It is used in the construction industry for two reasons:

  1. Retention provides an incentive for contractors to complete their work to the required standard and within the specified timeframe. By withholding a portion of the payment until project completion, clients can encourage contractors to remain committed to the project’s success.

  2. Retention acts as a form of protection for the client. In the event of defects or incomplete work, the retention amount can be used to rectify any issues or cover the cost of hiring another contractor to complete the outstanding tasks.

how retention in construction works

How does retention in construction work?

In construction contracts, retention is usually set at 5% of the total contract value. Meaning that each time you submit a monthly progress claim, 5% will be withheld from your receivable invoice.

For example, if you were to submit a $100,000 progress claim, the principal or head contractor will retain $5,000, and you will be paid $95,000.

This happens every time you submit a progress claim. So, if you were working on a $1,000,000 contract, you would have a total of $50,000 held back as retention throughout the project.

This money won’t be paid to you until the project reaches two key stages:

  1. Practical completion: You will receive half of the retention funds, so typically 2.5% of the contract value when the head contractor’s works are fully complete. For example, once a house is finished and ready for the owners to move in.

  2. Defects Liability Period (DLP): Following practical completion, the project enters the Defects Liability Period, usually spanning 6 to 12 months. During this period, the contractor is responsible for fixing any defects that occur in the build. For example, water leaks or ceiling cracks. Once the DLP expires, the remaining balance of the retention funds will be paid out, given that any defects have been fixed.

Of course, the idea of retention sounds simple in theory, but too often, the practice is abused. We’re talking funds not being released, regulations being ignored and serious cash flow issues. Definitely not cool!

But hey, don’t dwell on it — we’ve got some tips that’ll help you manage your retention like a pro.

Pro tip: Stay informed about legislation changes

On 5 October 2023, the New Zealand Government rolled out new updates to the Construction Contracts Act, which introduces new measures aimed at providing greater protection over contractors' retention money. 

Read what this means for contractors here →

How to manage the impact of retention in construction

Retention can often represent your entire profit margin on a job. So, getting it right is absolutely crucial. Here are 3 tips to help:

1. Plan your cash flow

Planning your cash flow is a way of looking into the future. With money coming in and out at different stages of your projects, having a cash flow forecast is pivotal.

It will help you identify the best times to spend your cash and the best times to save it by looking at your cash-in and cash-out timeline.

By anticipating cashflow shortages, you will be able to take pre-emptive actions to ensure you always have the required working capital, such as getting an overdraft from the bank.

how to manage the impact of retention in construction

2. Use construction project management software

Embracing technology can significantly streamline your retention management process.

With project management software, you can easily calculate retention amounts on your head and subcontractor claims, monitor the release of retention funds and maintain accurate records of all financial transactions.

That’s right! Project management software will simplify the entire retention and progress claims process based on your contract terms.

With just a few clicks, you can generate accurate retention amounts, eliminating the need for manual calculations and reducing your administrative burden. That’s helpful!

3. Maintain high work standards

One of the most simple and effective ways to manage the impact of retention in construction is to consistently deliver high-quality work.

By maintaining a focus on excellence throughout every phase of the construction process, you can minimise the risk of defects or incomplete work, which may lead to prolonged retention periods.

This involves closely monitoring the work progress, conducting regular quality checks and promptly addressing any issues that arise.

By upholding high work standards, you build a reputation for reliability, which can positively influence the release of retention funds.

Retention in construction — Wrapping it up

Retention plays a crucial role in the construction industry as a financial safeguard to ensure project success and uphold quality standards.

By withholding a fixed percentage of the total payment until project completion, retention motivates contractors to fulfil their commitments and deliver on their promises.

Understanding how retention works and managing its impact is crucial when growing a successful construction business.

From planning your cash flow to utilising construction project management software, implementing the right strategies can help you mitigate the challenges of retention and optimise project outcomes.

How we can help

At Lentune, we help construction companies streamline the way they handle project finances. Our clever project cost management software will help you calculate your retentions, manage your head and subcontractor claims and even save you hours each week. We’d love to show you how it works!

In a live demo, we can answer any questions and show you how Lentune could grow your business.

Book a demo