What Compensation Counts for a 401(k)?

There is no single universal "401(k) compensation" number.

A plan can legitimately use one compensation definition to calculate:

• employee elective deferrals

another for:

• employer matching contributions

another for:

• profit-sharing or nonelective allocations

and statutory definitions for:

• ADP/ACP or other nondiscrimination testing
• Section 415 limits
• top-heavy minimums
• HCE determinations.^[1][2][10]

The mistake is not having several definitions.

The mistake is using the wrong one for the job.

IRS identifies compensation-definition failures as a recurring 401(k) problem because payroll often operates from a convenient pay field while the signed plan document requires something different.^[1][2][9]

Key Takeaways

• A 401(k) can use several compensation definitions at the same time.
• The written plan controls compensation used for operational items such as deferrals, match and employer allocations, subject to statutory requirements.^[1][9]
• Section 415 compensation generally includes wages, salaries, commissions, tips, bonuses and specified other remuneration for personal services.^[5]
• Pre-tax elective deferrals can still be included in statutory compensation even though the deferred amount is not currently included in taxable wages.^[5]
• A raw W-2 Box 1 figure is not automatically the correct input for every retirement-plan calculation.
• A provision that requires Section 414(s) compensation must use a permitted definition or satisfy the applicable reasonableness and nondiscrimination standards.^[3][4]
• Overtime and bonuses can be excluded from an alternative Section 414(s) definition, but the exclusion cannot simply favor HCEs and must satisfy the regulatory test.^[3][4]
• The 2026 annual compensation limit under Section 401(a)(17) is $360,000.^[7][8][11]
• Reaching $360,000 of compensation does not automatically require salary deferrals to stop.^[6]
• Matching contributions remain subject to the compensation limit when the plan's formula uses compensation.^[6]
• Certain regular compensation paid after severance can remain Section 415 compensation when the regulatory timing conditions are met.^[5]
• Severance pay itself is not converted into Section 415 compensation merely because it is paid within the post-employment timing window.^[5]
• Compensation errors can require corrective contributions, reallocations or distributions rather than a prospective payroll change alone.^[1][9]

Start With the Purpose, Not the Payroll Field

The cleanest way to administer compensation is to stop asking:

What is this employee's compensation?

Ask instead:

Compensation for what?

A useful plan-level map looks like this:

A TPA can calculate every percentage correctly and still produce the wrong answer if the compensation column feeding the test is wrong.

"Plan Compensation" Is a Defined Term

Most plan documents define Compensation somewhere in the document or adoption agreement.

That definition can start from a recognized compensation base and then make permitted adjustments.

The document may specify whether to include or exclude items such as:

• bonuses
• overtime
• commissions
• taxable fringe benefits
• expense allowances
• elective deferrals
• compensation before plan entry
• compensation after termination.

IRS directs sponsors to follow the compensation definition in the written plan when calculating plan deferrals and allocations.^[1][9]

Do not substitute the payroll vendor's default field.

The Same Pay Code Can Count for One Purpose and Not Another

Assume the plan says:

Elective deferrals

Base salary + bonus

Match

Base salary only

Annual pay consists of:

• base salary: $100,000
• bonus: $20,000

Employee elects:

10% deferral

The deferral feature can require the employee to receive an opportunity to defer from:

$120,000

while the match formula may use:

$100,000

if the plan is validly written that way.

The difference is not inherently an error.

Using the base-salary-only field for both calculations would be.

Example: Bonus Omitted From Deferral Compensation

Plan requires bonuses to be included.

Employee receives:

• base pay: $100,000
• annual bonus: $20,000
• deferral election: 10%

Payroll applies the election only to base pay.

Actual elective deferral:

$10,000

Had the plan terms been followed on the bonus, the employee would also have been offered the opportunity to defer:

10% × $20,000 = $2,000

The issue is not that every plan must include bonuses.

The issue is that this plan did.

IRS uses the same type of failure in its compensation-error guidance.^[9]

Bonuses Are Neither Always In Nor Always Out

A bonus can be:

• included for elective deferrals
• excluded for elective deferrals
• included for matching
• excluded for matching
• included in statutory testing compensation
• excluded from an alternative Section 414(s) definition if the regulatory requirements are satisfied.^[1][3][4]

So the question:

"Do bonuses count in a 401(k)?"

has no responsible one-word answer.

Read the plan provision and identify the purpose.

Overtime Creates a Different Risk

A plan may exclude overtime from the compensation used for a contribution formula.

That does not automatically mean the same exclusion can be used for nondiscrimination testing.

IRS gives this exact warning: if overtime is concentrated among NHCEs, excluding it can distort the compensation base used for ADP testing or another provision that requires Section 414(s) compensation.^[1]

The payroll rule and the testing rule must be checked separately.

Section 414(s) Is a Testing Standard, Not a Universal Plan-Pay Definition

Section 414(s) applies when another qualification rule specifically calls for compensation that satisfies Section 414(s).^[4]

That distinction matters.

A plan is not required to use Section 414(s) compensation for every actual contribution formula merely because Section 414(s) exists.^[4]

The plan can have:

• one definition for benefit or contribution calculations
• another compliant definition for a test that explicitly requires Section 414(s).

This is why "we use 414(s) compensation" is incomplete unless the speaker says for which purpose.

Definitions That Automatically Meet the Section 414(s) Standard

Treasury regulations identify compensation definitions that meet the Section 414(s) standard without a separate compensation nondiscrimination test.^[4]

One route is to use compensation within the meaning of Section 415(c)(3).

Permitted safe-harbor variations also exist.^[3][4]

The advantage is administrative certainty.

The trade-off is that a broader definition may include pay categories the employer would prefer to exclude from a contribution formula.

Alternative Section 414(s) Definitions

An alternative compensation definition can also qualify under Section 414(s) when it:^[4]

1. does not by design favor HCEs
2. is reasonable
3. passes the regulatory nondiscrimination requirement.

The regulations permit reasonable exclusions of specified irregular or additional compensation, including items such as:^[4]

• overtime
• shift differentials
• call-in premiums
• bonuses.

"Permitted to exclude" is not the same as:

automatically safe to exclude.

The resulting definition still has to satisfy the applicable test.

Example: Excluding Overtime Can Change the HCE/NHCE Comparison

Assume two employee groups.

HCEs

Mostly salaried. Little overtime.

NHCEs

Hourly. Material overtime.

If testing compensation excludes overtime, the percentage of total pay included for NHCEs can be materially lower than the percentage included for HCEs.

That is the direction of distortion Section 414(s) is designed to catch.

An exclusion that looks neutral as a payroll code can be non-neutral in effect.

Section 415 Compensation Is Broader Than Base Salary

The Section 415 regulation generally includes remuneration for personal services such as:^[5]

• wages
• salaries
• professional-service fees
• commissions
• tips
• bonuses
• specified fringe benefits
• nonaccountable expense allowances.

It also contains detailed exclusions and timing rules.

Do not reduce Section 415 compensation to:

regular salary

unless the regulation and facts actually produce that number.

Elective Deferrals Can Still Be Compensation

Suppose an employee earns:

$120,000

and elects a pre-tax 401(k) deferral of:

$12,000

The deferral reduces the amount currently included in federal taxable wages under the applicable tax rules.

Section 415 compensation can still include amounts that would have been received and includible in income but for specified elections, including a 401(k) election.^[5]

That is one reason a raw taxable-wage field can understate retirement-plan compensation.

W-2 Box 1 Is Not a Universal Retirement-Plan Field

Box 1 is useful.

It is not magic.

A W-2-based safe-harbor compensation definition can require specified adjustments, and other plan purposes use other definitions.^[3][5]

Common sources of mismatch include:

• pre-tax 401(k) deferrals
• Section 125 cafeteria-plan elections
• qualified transportation elections
• fringe benefits
• nonaccountable reimbursements
• nonqualified deferred compensation.

The correct input depends on the chosen legal definition.

The 2026 Compensation Cap Is $360,000

For 2026, the applicable annual compensation ceiling is:

$360,000.^[7][8][11]

The limit increased from:

$350,000 in 2025.^[8][11]

That cap matters when the plan takes compensation into account for specified contribution and benefit calculations.

It is not the same thing as the annual elective-deferral limit.

Three Different Dollar Limits Should Not Be Blended

For a traditional 401(k), three separate concepts can appear in the same year:

Compensation limit

2026 compensation ceiling for applicable plan calculations:

$360,000.^[7][8]

Elective-deferral limit

2026 basic Section 402(g) limit:

$24,500.^[7][8]

Annual-additions limit

2026 Section 415(c) dollar limit:

$72,000

before applicable catch-up treatment, subject also to the percentage-of-compensation limitation.^[7]

Each limit solves a different problem.

Earning $360,000 Does Not Automatically Stop Deferrals

Unless plan terms say otherwise, a participant can continue making elective deferrals after year-to-date pay exceeds the annual compensation ceiling, until another applicable deferral restriction is reached.^[6]

The compensation cap does not automatically switch payroll deferrals off.

Example: $480,000 Employee Keeps Deferring

Monthly salary is:

$40,000

Annual salary:

$480,000

Assume the employee elects:

$2,000 per month

and the document does not require deferrals to stop when pay reaches the annual compensation ceiling.

After nine months, cumulative pay reaches:

$360,000

The employee has deferred:

$18,000

The participant can generally continue deferring in later payroll periods until the applicable elective-deferral limit or another plan restriction is reached.^[6]

The $360,000 compensation cap did not consume the employee's remaining Section 402(g) capacity.

A Plan Can Write a Different Deferral Rule

IRS also notes that a plan can specifically require salary deferrals to stop once compensation used by the plan reaches the annual compensation limit.^[6]

If the document says that, the sponsor has to operate that rule.

This creates two plans with the same federal limits but different employee outcomes.

Plan A

Deferrals continue beyond the compensation cap until the elective-deferral limit is reached.

Plan B

Document stops deferrals when the plan's compensation ceiling is reached.

Both require the payroll system to follow the actual document.

Matching Contributions Are Different

A match formula that uses compensation is constrained by the applicable compensation limit.^[6]

Assume 2026 plan formula:

50% match on deferrals up to 6% of compensation

Annual pay:

$480,000

Maximum compensation used for the formula:

$360,000

Maximum deferrals recognized for this match calculation:

6% × $360,000 = $21,600

Maximum employer match:

50% × $21,600 = $10,800

The employee can potentially make elective deferrals beyond $21,600 subject to applicable limits.

The extra deferral does not create more matching compensation under this formula.

Compensation Cap and Deferral Limit Can Cross in Either Order

A lower-paid employee can hit the elective-deferral dollar limit without coming close to the compensation cap.

A highly paid employee can cross $360,000 of pay before reaching the elective-deferral limit.

Those are independent boundaries.

Payroll controls should monitor them separately.

Safe-Harbor Plans Add a Compensation Requirement

A safe-harbor 401(k) must base applicable safe-harbor benefits and contributions on compensation that satisfies Section 414(s).^[3]

That makes the compensation definition part of the safe-harbor design.

A plan cannot casually exclude a pay category from safe-harbor compensation and assume the safe harbor remains intact.

Safe-Harbor Compensation Can Be Limited to the Eligible Period

IRS explains that a safe-harbor plan can define compensation for a newly eligible participant using:^[3]

• compensation during the participant's eligible period, or
• compensation for the full plan year

when the plan is written and applied consistently.

Example: September 1 Entry

Calendar-year safe-harbor plan.

Employee enters:

September 1

Plan provides a:

3% nonelective contribution

One permitted design can use compensation from:

September 1–December 31

Another can use full-year compensation, if the plan is written accordingly and the rule is applied uniformly.^[3]

The employee's hire date alone does not answer the contribution base.

The compensation period is a plan term.

Pre-Entry Compensation Can Matter Even When the Employee Could Not Defer Yet

Suppose an employee becomes eligible midyear.

For elective deferrals, the employee obviously could not make plan deferrals before the entry date.

For an employer contribution, the plan might use:

• compensation only while eligible
• full-year compensation

depending on plan terms and applicable law.^[3]

Do not infer the employer-contribution base from the deferral period.

Post-Severance Compensation Has a Specific Timing Rule

Section 415 compensation is generally tied to pay made or available during the limitation year and, as a starting rule, before severance from employment.^[5]

The regulation then creates an important exception for certain payments made after severance.

Qualifying payments can remain compensation when paid by the later of:^[5]

• 2½ months after severance
• the end of the limitation year containing the severance date.

The type of payment still matters.

Timing alone is not enough.

Regular Pay After Severance Can Count

The post-severance rule can preserve regular compensation for services performed before the employee left when the amount would have been paid earlier had employment continued.^[5]

The regulation specifically reaches items such as:

• regular pay
• overtime
• shift differential
• commissions
• bonuses
• similar payments.^[5]

Example: Commission Paid After Departure

Salesperson earns a commission before leaving employment.

Severance date:

October 15

Commission is paid:

November 30

Assume the commission would have been paid on November 30 even if the employee had remained employed.

That fact pattern can fit the regular post-severance compensation rule, subject to the plan and regulatory requirements.^[5]

Calling the payment:

post-termination

does not automatically make it severance pay.

Leave Cashouts Need Plan Language

A plan may provide for specified unused accrued bona fide:^[5]

• sick leave
• vacation
• other leave

paid after severance to count as Section 415 compensation when the regulatory timing conditions are satisfied and the employee could have used the leave if employment had continued.^[5]

This treatment is not simply:

all PTO cashouts always count.

The regulation and plan provision matter.

Severance Pay Is Different

The same regulation expressly distinguishes severance pay paid after severance from qualifying regular post-employment compensation.^[5]

A payment does not become Section 415 compensation merely because:

• it arrives within 2½ months
• payroll reports it as wages
• tax withholding applies.

Identify what the payment represents.

Timing Does Not Rescue the Wrong Payment Type

Use a two-gate analysis.

Gate 1: Payment type

Is the payment:

• qualifying regular compensation
• permitted leave cashout
• qualifying nonqualified deferred compensation
• something else?

Gate 2: Timing

Was it paid within the regulatory window?

A payment that fails Gate 1 does not become valid Section 415 compensation by passing Gate 2.^[5]

Self-Employed Compensation Uses a Different Calculation

A sole proprietor or partner does not use ordinary W-2 salary as the employer-contribution base for self-employment activity.

Section 415 compensation for a self-employed individual uses earned income under the applicable rules.^[5][11]

INV-030 explains why solo 401(k) employer-contribution math for a sole proprietor or partner differs from simply multiplying Schedule C profit by the plan's stated employee contribution percentage.

This is another reason "compensation" cannot be one payroll field across every participant.

HCE Classification Uses Statutory Compensation

INV-084 explains HCE status.

For the HCE compensation test, IRS specifies Section 415(c)(3) compensation rather than whatever narrow compensation definition the plan happens to use for match calculations.^[10]

An employer therefore cannot reduce an employee's HCE compensation by saying:

"Our match excludes bonuses."

The HCE test uses its required statutory compensation rule.

Top-Heavy Minimums Also Need the Correct Statutory Base

INV-086 covers top-heavy plans.

IRS warns that top-heavy minimum benefits and other statutory limits require the applicable statutory compensation definition.^[2]

A sponsor that uses:

base salary only

for every plan calculation can understate a required minimum when the statutory rule includes additional compensation.

The top-heavy calculation and ordinary employer match do not necessarily share the same pay base.

ADP/ACP Testing Can Require a Different Compensation File Than Payroll Uses for Match

INV-087 and INV-088 cover ADP and ACP.

A plan might exclude:

overtime

from its matching formula.

If the test requires Section 414(s)-compliant compensation, the sponsor must validate that testing definition independently.^[1][4]

This means the TPA census may need two compensation columns:

• plan allocation compensation
• testing compensation.

One number is simpler.

Two correct numbers are better.

A Compensation Error Can Run in Either Direction

Under-inclusion

Plan requires bonus to count. Payroll omits it.

Possible effects:

• missed deferral opportunity
• understated match
• understated employer allocation.

Over-inclusion

Plan excludes bonus. Payroll includes it.

Possible effects:

• excessive deferrals under the plan's own terms
• excess match
• excess profit-sharing allocation.

Both are operational failures if the plan is not operated according to its written compensation provision.^[1][9]

"The Employee Benefited" Does Not Automatically Cure Over-Inclusion

Suppose payroll mistakenly included bonuses even though the plan document excluded them.

Participants received larger contributions.

That can feel harmless.

It is still a mismatch between plan terms and operations.

IRS correction rules sometimes permit a retroactive conforming amendment under specified conditions, but not every favorable operational error can simply be blessed after the fact.^[9][12]

The correction route depends on the facts.

Correcting Compensation Errors Can Require Money, Not Just a Setting Change

IRS lists possible corrections including:^[1]

• corrective contributions
• reallocations
• distributions

depending on the failure.

If a bonus should have been available for a deferral election but was omitted, changing next year's payroll configuration does nothing for the lost prior-year opportunity.

The historical period has to be addressed.

The Payroll-to-Plan Compensation Map

For every payroll pay code, create a matrix.

The matrix should come from the plan document and statutory requirements.

Do not build it from historical payroll behavior.

Reconcile the Map to Actual Payroll Codes

Plan documents use legal terms.

Payroll uses labels such as:

• REG
• OT
• BONUS
• COMM
• PTO
• PTO-CASH
• AUTO
• CAR
• SEV
• RETRO.

Someone has to connect those languages.

A plan can say:

all Section 415 compensation

while payroll sends the recordkeeper only:

REG + BONUS

That translation layer is where many compensation failures originate.

New Pay Codes Need a Benefits Review

A company adds:

Shift Premium 2

or:

Retention Bonus

Payroll can configure tax withholding without asking whether the pay code belongs in 401(k) compensation.

That is not enough.

Every new compensation category should be mapped before the first payment if possible.

Ask:

• Is it compensation under the plan definition?
• Does it enter deferral compensation?
• Does it enter the match formula?
• Does it belong in testing compensation?
• Does Section 415 include it?
• Is it paid before or after severance?

Plan Amendments Can Break a Previously Correct Payroll Map

IRS identifies amendments as a common source of compensation errors.^[9]

Example:

Old plan

Excludes bonus.

Amendment

Includes bonus effective January 1.

Payroll

Still uses last year's compensation code mapping.

Nothing looks broken in the payroll system.

The legal rule changed.

A compensation amendment should trigger a configuration review across:

• payroll
• recordkeeper
• TPA
• HR documentation
• employee election forms.

The Annual Compensation Limit Should Be a Separate Control

For 2026, test the compensation base against:

$360,000.^[7][8]

Do not rely on the same control that monitors:

$24,500 elective deferrals.^[7][8]

They are different limits.

If payroll uses one alert called:

401(k) max reached

the system can stop the wrong thing.

Frequently Asked Questions

What compensation counts for a 401(k)?

It depends on the plan purpose. The written plan determines compensation for items such as deferrals and employer allocations, while statutory definitions can apply to testing, Section 415 limits, HCE determinations and top-heavy rules.^{[1][2][5][10]}

Do bonuses count toward a 401(k)?

They can. A plan can include or exclude bonuses for specified operational purposes, subject to applicable qualification and nondiscrimination rules.^[1][3][4]

Does overtime count?

It can. Overtime is generally within broad Section 415 compensation, but a plan can exclude overtime for some contribution purposes. A Section 414(s) testing definition requires a separate nondiscrimination analysis when using an alternative exclusion.^[4][5]

Do commissions count?

Commissions are expressly among the types of remuneration included in the general Section 415 compensation definition.^[5] Plan contribution treatment still depends on the applicable plan provision.

Is W-2 Box 1 the 401(k) compensation number?

Not necessarily. Some compliant definitions are W-2-based, but statutory adjustments and plan-specific inclusions or exclusions can produce a different number.^[3][5]

Do my pre-tax 401(k) deferrals reduce retirement-plan compensation?

Not necessarily. Section 415 compensation includes specified amounts that would have been taxable but for an employee deferral election.^[5]

What is the 401(k) compensation limit for 2026?

For 2026, the applicable annual compensation ceiling is $360,000.^[7][8][11]

Does my 401(k) deferral have to stop when I earn $360,000?

No, not automatically. IRS states that elective deferrals can continue after compensation exceeds the annual compensation limit unless the plan terms provide otherwise, subject to the applicable deferral limit.^[6]

Can the employer match compensation above $360,000?

The matching formula cannot use pay above the year's applicable statutory compensation ceiling.^[6]

Are the $360,000 compensation limit and $24,500 deferral limit the same thing?

No. They are separate 2026 limits serving different purposes.^[7][8]

Can a safe-harbor 401(k) exclude bonuses?

A safe-harbor plan must use Section 414(s)-compliant compensation. A definition excluding bonuses is permissible only if it meets the applicable nondiscrimination requirements.^[3][4]

Can a plan use compensation only after I become eligible?

For specified safe-harbor contribution purposes, IRS guidance permits compensation to be limited to the participant's eligible period or to use full-plan-year compensation if the plan is written and applied accordingly.^[3]

Does pay received after termination count?

Certain regular compensation, commissions, bonuses and other qualifying amounts can remain Section 415 compensation when they satisfy the post-severance type and timing rules.^[5]

Does severance pay count because it was paid within 2½ months?

No. The regulation specifically distinguishes severance pay from qualifying post-severance compensation.^[5]

Can a PTO cashout count after termination?

A plan can provide for specified unused bona fide leave cashouts to count when the employee could have used the leave if employment continued and the timing requirements are satisfied.^[5]

Does the HCE test use the plan's match compensation definition?

Not necessarily. HCE compensation is determined under the statutory Section 415(c)(3) compensation rule for the compensation test.^[10]

What happens if payroll used the wrong compensation definition?

The plan can have an operational failure. IRS correction can require contributions, reallocations or distributions depending on the facts.^[1][9]

The Five-Column Compensation Check

Before sending the annual census or approving a new payroll code, identify five numbers for each affected employee:

1. deferral compensation
2. matching compensation
3. nonelective/profit-sharing compensation
4. testing compensation
5. Section 415/statutory compensation

Then ask whether the 2026 $360,000 annual compensation cap applies to the calculation being performed.

The safest assumption is not:

all five columns should match.

The safer rule is:

every column needs a legal reason for the number it contains.

Sources & References

1. IRS: 401(k) Fix-It Guide — Incorrect Plan Definition of Compensation
2. IRS: Avoiding Compensation Errors in Retirement Plans
3. IRS: Compensation Definition in Safe Harbor 401(k) Plans
4. 26 CFR §1.414(s)-1: Definition of Compensation
5. 26 CFR §1.415(c)-2: Compensation
6. IRS: 401(k) Deferrals and Matching When Compensation Exceeds the Annual Limit
7. IRS: 401(k) and Profit-Sharing Plan Contribution Limits
8. IRS Notice 2025-67: 2026 Cost-of-Living Adjustments
9. IRS: Plan Compensation Errors — Plan Definition Differs From Operations
10. IRS: Identifying Highly Compensated Employees in an Initial or Short Plan Year
11. IRS Publication 560: Retirement Plans for Small Business
12. IRS: Retirement Plan Errors Eligible for Self-Correction

Educational Disclaimer

ROIStreet publishes educational content about retirement-plan compensation and administration. This article is not legal, tax, employment, fiduciary or plan-administration advice. Compensation treatment depends on the plan document, pay type, participant status, contribution source, testing purpose, payment timing and current law.

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We strive to explain before we evaluate, present evidence before opinions, discuss risks alongside potential benefits, distinguish facts from analysis, and correct material errors transparently.

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