In a 401(k) plan, eligible compensation is the specific portion of your pay the plan uses to calculate how much you and your employer can contribute. It is not your total earnings, and it is not always what shows up in Box 1 of your W-2. Regular salary, hourly wages, commissions, overtime, and cash bonuses almost always count. Expense reimbursements, most stock-based pay, and non-qualified deferred compensation almost never do. Everything else depends on the definition your plan document adopts and on a $360,000 annual cap for 2026.
Pay Types That Count
Under the common plan definitions, the bulk of your cash pay qualifies. Regular salary, hourly wages, and commissions are included regardless of which definition your plan uses. These are direct pay for work performed, and no plan carves them out.
Cash bonuses count as well. Sign-on bonuses, performance bonuses, and profit-sharing payments all increase your compensation base and, in turn, your contribution potential. Overtime pay is treated the same way; the extra hours are part of your total wages subject to withholding.
Pre-tax deferrals are where plans diverge, but most add them back in. Your 401(k) elective deferrals, salary reductions for health insurance under a cafeteria plan, and pre-tax HSA contributions through payroll are generally included in the compensation base. The Section 415 definition requires this by statute.1Office of the Law Revision Counsel. 26 USC 415 – Limitations on Benefits and Contribution Under Qualified Plans Plans built on W-2 Box 1 or Section 3401 compensation often adopt modifications that reach the same result.
Certain taxable fringe benefits are in the count too. The most common example is employer-provided group term life insurance coverage above $50,000. The imputed cost of that excess coverage is reported as taxable income and is typically included in eligible compensation.2Internal Revenue Service. Group-Term Life Insurance
Pay Types That Are Excluded
Not everything your employer pays you belongs in the compensation base. The excluded items generally fall into two groups: reimbursements that put you back to even, and benefits that aren’t pay for services.
Expense reimbursements for travel, mileage, or supplies don’t count. Neither do qualified transportation fringe benefits or dependent care assistance. These are non-taxable benefits excluded from compensation under most plan definitions.3Internal Revenue Service. Compensation Definition in Safe Harbor 401(k) Plans
Non-qualified deferred compensation is almost always excluded. Those arrangements involve a separate contractual promise to pay you in the future, and the amounts aren’t treated as current compensation for 401(k) purposes.
Stock-based compensation trips people up. Under the general Section 415 definition, the spread from exercising non-qualified stock options is not included in compensation. Income from RSU vesting under Section 83 is likewise excluded. Plans that use the W-2 or Section 3401(a) definitions may technically pick up NSO exercise income because it appears as taxable wages, but many plans specifically exclude it to avoid wild year-to-year swings in the compensation base.
Severance pay depends entirely on your plan document. If the plan defines compensation as amounts paid while you’re an active employee, severance paid after your last day won’t count. Disability payments, short-term or long-term, are generally excluded because they’re welfare benefits, not pay for services rendered.
Pay Received After You Leave
Your final paycheck isn’t necessarily the end of the story. Pay received after you leave a job can still count as eligible compensation, but only if two conditions are met: the amounts would have been included in compensation had they been paid while you were still employed, and they’re paid by the later of 2½ months after your separation or the end of the plan’s limitation year that includes your separation date.4eCFR. 26 CFR 1.415(c)-2 – Compensation
This matters most for accrued but unused vacation or sick leave. If you would have been able to use that leave had you stayed, the cash-out can count, but the plan document must permit it and the payment must land within the timing window. Regular pay, commissions, and bonuses earned before you left also qualify under these rules if they’re paid on time.
Differential wage payments for employees called to active military duty fall under separate rules established by the HEART Act. Those payments are treated as compensation under Section 415, though plans aren’t required to include them when calculating contributions.5Internal Revenue Service. Miscellaneous HEART Act Changes Notice 2010-15
Why Two Plans Can Count Your Pay Differently
Every 401(k) plan document must spell out which definition of compensation it uses, and it must apply that definition the same way for every participant.6Internal Revenue Service. 401(k) Plan Fix-It Guide – You Didn’t Use the Plan Definition of Compensation Correctly for All Deferrals and Allocations The IRS allows three primary options.
Section 415 Compensation
This is the broadest definition. It covers wages, salaries, commissions, bonuses, and fees for professional services, and it counts pre-tax amounts you elect to defer. Your 401(k) contributions, cafeteria plan salary reductions for health insurance, and similar pre-tax elections all stay in the compensation base.1Office of the Law Revision Counsel. 26 USC 415 – Limitations on Benefits and Contribution Under Qualified Plans Section 415 also sets the outer ceiling for annual additions, so no other definition can produce a larger number.
W-2 Box 1 Compensation
This definition uses the figure in Box 1 of your Form W-2, the amount subject to federal income tax withholding.7Internal Revenue Service. Chapter 3 Compensation It’s administratively simple because payroll systems already calculate it, but Box 1 is reduced by your pre-tax 401(k) deferrals, cafeteria plan contributions, and HSA payroll deductions. The more you defer, the smaller the base becomes. Many plans use a “modified W-2” definition that adds pre-tax deferrals back in to avoid that feedback loop.3Internal Revenue Service. Compensation Definition in Safe Harbor 401(k) Plans
Section 3401(a) Compensation
Section 3401(a) defines wages as all remuneration for services performed, minus specific statutory exceptions.8Office of the Law Revision Counsel. 26 USC 3401 – Definitions In practice this lands close to Section 415 because it typically includes pre-tax deferrals. Many plan sponsors favor it for calculating employee contributions because participating in a cafeteria plan or HSA doesn’t shrink the base.
To find out which one applies to you, check the compensation definition in your summary plan description or plan document.
The $360,000 Cap for 2026
Even if you earn $500,000 a year, your 401(k) plan can only use the first $360,000 of your compensation for 2026. This cap, set by Section 401(a)(17), applies to every contribution calculation: your own deferrals, your employer’s match, and profit-sharing allocations.9Internal Revenue Service. 2026 Amounts Relating to Retirement Plans and IRAs, as Adjusted for Changes in Cost-of-Living
The cap bites hardest on employer matching formulas. If your plan matches 50% of deferrals up to 5% of compensation, the 5% is calculated against $360,000 at most, not your actual salary. An employee earning $400,000 gets the same maximum match as one earning $360,000.10Internal Revenue Service. Deferrals and Matching When Compensation Exceeds the Annual Limit Certain governmental plans that preserved cost-of-living adjustments under rules in effect on July 1, 1993 use a higher cap of $535,000 for 2026.
If You’re Self-Employed
Running a solo 401(k) changes the math. Your compensation isn’t a W-2 figure. It’s your net earnings from self-employment, reduced by both the deductible portion of your self-employment tax and your own retirement plan contribution.11Internal Revenue Service. Self-Employed Individuals – Calculating Your Own Retirement Plan Contribution and Deduction
Because you’re subtracting the contribution to figure out the base that determines the contribution, the IRS provides rate tables and worksheets to break the loop. The practical effect: a 25% employer contribution rate works out to roughly 20% of net self-employment income before the plan deduction. The $360,000 annual compensation cap and the $72,000 total additions limit still apply.12Internal Revenue Service. Retirement Plans for Self-Employed People
How the Number Drives Your Contribution Limits
Your eligible compensation figure feeds into three layered IRS limits.
For 2026, you can defer up to $24,500 of your own pay into a 401(k).13Internal Revenue Service. 401(k) Limit Increases to $24,500 for 2026, IRA Limit Increases to $7,500 That’s a hard dollar cap, but you also can’t defer more than 100% of your eligible compensation. Participants aged 50 or older get an additional $8,000 catch-up, and participants aged 60 through 63 get $11,250 under SECURE 2.0, bringing the personal ceiling to $35,750.
The combined total of your deferrals, employer matching, and employer profit-sharing contributions cannot exceed the lesser of $72,000 or 100% of your Section 415 compensation for 2026.14Internal Revenue Service. COLA Increases for Dollar Limitations on Benefits and Contributions Catch-up contributions don’t count toward this limit, so a participant aged 60 through 63 could receive up to $83,250 in total plan contributions.1Office of the Law Revision Counsel. 26 USC 415 – Limitations on Benefits and Contribution Under Qualified Plans
Eligible compensation also serves as the denominator when the plan runs its annual non-discrimination tests. Each participant’s deferral is divided by their eligible compensation, and those ratios are averaged for highly compensated employees (those earning more than $160,000 in 2026) and everyone else.14Internal Revenue Service. COLA Increases for Dollar Limitations on Benefits and Contributions A broader compensation definition produces a larger denominator, a lower percentage for higher earners, and a better shot at passing the test. That’s one reason the choice of definition is a strategic decision for plan sponsors, not just an administrative one.
If the pay types included in your plan look off, ask your plan administrator for the compensation definition in the plan document and reconcile it against your pay stubs before the year ends. Corrections after the fact are possible, but they involve the plan sponsor, not you.