Eligible compensation in a 401(k) is the specific portion of your pay that your plan uses to calculate how much you and your employer can contribute, and it is not the same as your gross earnings. For 2026, only the first $360,000 of that pay counts, and the exact pay types included depend on the definition written into your plan document. Most plans sweep in salary, hourly wages, overtime, commissions, cash bonuses, and your own pre-tax deferrals, while leaving out expense reimbursements, most non-taxable fringe benefits, and stock-based compensation.
The $360,000 Cap That Sits on Top of Everything
No matter how your plan defines compensation, Section 401(a)(17) caps the figure at $360,000 for 2026.1Internal Revenue Service. 2026 Amounts Relating to Retirement Plans and IRAs, as Adjusted for Changes in Cost-of-Living Earn $500,000 and your plan still has to pretend you earned $360,000 when it calculates deferrals, matching, and profit-sharing allocations.
The cap bites hardest on employer matching. If your plan matches 50% of deferrals up to 5% of pay, that 5% is measured against $360,000 at most. A worker earning $400,000 receives the same maximum match as one earning $360,000.2Internal Revenue Service. Deferrals and Matching When Compensation Exceeds the Annual Limit Certain governmental plans grandfathered under rules in effect on July 1, 1993 use a higher cap of $535,000 for 2026.
What Counts as Eligible Compensation
Under the common plan definitions, the bulk of your cash pay is in. Regular salary, hourly wages, and commissions are always counted. These are direct pay for work performed and no definition excludes them.
Cash bonuses count too. Sign-on bonuses, performance bonuses, and profit-sharing payouts all increase your compensation base and, with it, your contribution potential. Overtime pay is included because it is part of your total wages subject to withholding.
Pre-tax deferrals are generally added back into the compensation base. Your own 401(k) elective deferrals, your salary reductions for health insurance under a cafeteria plan, and your pre-tax HSA contributions through payroll are typically included. Section 415 compensation requires this by statute.3Office of the Law Revision Counsel. 26 USC 415 – Limitations on Benefits and Contribution Under Qualified Plans Plans using a W-2 or Section 3401(a) definition often adopt a modification that reaches the same result.
Some taxable fringe benefits are included. The most common is employer-provided group term life insurance above $50,000 of coverage. The imputed cost of the excess coverage is reported as taxable income and is typically folded into eligible compensation.4Internal Revenue Service. Group-Term Life Insurance
What Doesn’t Count
Not every dollar your employer hands you belongs in the compensation base. The exclusions mostly fall into two groups: payments that reimburse you for something, and benefits that aren’t really pay for services.
Expense reimbursements for travel, mileage, and supplies are out. So are qualified transportation fringe benefits and dependent care assistance, which most plan definitions exclude as non-taxable benefits.5Internal Revenue Service. Compensation Definition in Safe Harbor 401(k) Plans
Non-qualified deferred compensation is almost always excluded. It represents a separate contractual promise to pay you in the future rather than current wages.
Stock-based compensation is where many people get tripped up. Under the general Section 415 definition, the spread you recognize when exercising non-qualified stock options is not counted, and income from RSU vesting under Section 83 is also excluded. Plans built on the W-2 or Section 3401(a) definitions could technically pick up NSO exercise income because it appears as taxable wages, but many plans explicitly exclude it anyway to avoid year-to-year swings in the compensation base.
Severance pay depends on the plan document. If your plan defines compensation as amounts paid while you are an active employee, severance paid after your last day on the job won’t count. Disability payments, both short- and long-term, are generally excluded because they are welfare benefits rather than pay for services rendered.
Why Your Plan’s Definition Matters
Every 401(k) plan document picks one of three IRS-approved definitions and applies it the same way for everyone.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 three options give you slightly different numbers.
Section 415 Compensation
This is the broadest definition and the one the IRS treats as the ceiling. It covers wages, salaries, commissions, bonuses, and fees for professional services, and it keeps your pre-tax 401(k) deferrals and cafeteria plan elections in the base.3Office of the Law Revision Counsel. 26 USC 415 – Limitations on Benefits and Contribution Under Qualified Plans Because nothing is subtracted when you participate in pre-tax benefits, Section 415 gives you the largest number to work with.
W-2 Box 1 Compensation
This uses the figure in Box 1 of your W-2, the amount subject to federal income tax withholding.7Internal Revenue Service. Chapter 3 Compensation It is easy for payroll to produce. The trap is that Box 1 is already reduced by your pre-tax 401(k) deferrals, cafeteria plan contributions, and HSA payroll deductions. The more you defer pre-tax, the smaller the compensation base used to calculate your contribution limit, which creates a feedback loop. Many plans fix this by using a “modified W-2” definition that adds pre-tax deferrals back in.5Internal Revenue Service. Compensation Definition in Safe Harbor 401(k) Plans
Section 3401(a) Compensation
Section 3401(a) defines wages as all pay for services, minus specific statutory exceptions.8Office of the Law Revision Counsel. 26 USC 3401 – Definitions In practice it lands close to Section 415 because it typically includes pre-tax deferrals, so participating in a cafeteria plan or HSA does not shrink the base.
Your Summary Plan Description will tell you which one your plan uses. If you are deferring heavily and your plan uses straight W-2 Box 1 with no add-back, the number driving your match may be meaningfully smaller than you think.
Pay Received After You Leave
Your final paycheck is not necessarily the end of the compensation count. Pay received after you leave a job can still qualify, but only if it would have been included had you still been employed and it is paid by the later of two dates: 2½ months after your separation, or the end of the plan’s limitation year that includes your separation date.9eCFR. 26 CFR 1.415(c)-2 – Compensation
This matters most for cash-outs of unused vacation or sick leave. If you could have used that leave while employed, the payout can count, but the plan document has to permit it and the payment has to land inside that window. Final regular pay, commissions, and bonuses earned before you left also qualify if they’re paid in time. Differential wage payments for employees called to active military duty are treated as compensation under Section 415 under separate rules established by the HEART Act, though plans are not required to include them when calculating contributions.10Internal Revenue Service. Miscellaneous HEART Act Changes Notice 2010-15
If You Are Self-Employed
A solo 401(k) uses a different base entirely. Your “compensation” is 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. 12Internal Revenue Service. Retirement Plans for Self-Employed People
If Your Employer Used the Wrong Number
Using the wrong compensation definition is one of the most common 401(k) administration mistakes, and the fix depends on which way the error went. If you contributed more than you should have, the excess, plus earnings, must be distributed back to you and any related employer match must be forfeited. If you contributed less than you were entitled to, the employer owes a corrective contribution equal to 50% of the missed deferral, adjusted for earnings from when the deferral should have happened. You are immediately and fully vested in that corrective amount. Errors caught and fixed quickly may qualify for a reduced 25% corrective contribution.6Internal Revenue Service. 401(k) Plan Fix-It Guide – You Didn’t Use the Plan Definition of Compensation Correctly for All Deferrals and Allocations
If you think your match or deferrals have been running off the wrong base, compare your pay stubs and W-2 against the compensation definition in your plan’s Summary Plan Description, then raise the discrepancy with your plan administrator in writing. The employer has established IRS correction paths available to make you whole.