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Retirement Services

401(k)ology – Payroll Calculation Conundrums

By Joni L. Jennings, CPC, CPFA®, NQPC™ | Published March 3, 2026

Many 401(k) plans are falling into subtle payroll traps, exposing the plan to compliance risk because the payroll service or software does not correctly apply the compensation dollar limits, or does not correctly calculate the per pay period match. The compensation and deferral limits are published as annual limits. How does that work on a per pay period basis? This post explains how misunderstanding the plan provisions and statutory limits leads to match calculation errors, potential plan corrections, and what payroll and HR teams need to know to prevent compliance errors.

401(k) plan operational failures are often rooted in payroll systems. One of the most common trouble spots is how compensation is treated under Internal Revenue Code §401(a)(17) for employee deferrals versus employer matching contributions. The nuances trip up even very sophisticated employers.

In this post, we discuss the annual compensation limit, outline how that limit may apply differently for deferrals versus match, highlight common payroll errors related to compensation, and provide insight into preventing these errors. Be forewarned that there will be a lot of math involved!

Quick Refresher: What Is the §401(a)(17) Compensation Limit?

The §401(a)(17) limit is the maximum annual compensation that can be considered for qualified retirement plans. In practical terms:

• Plans cannot base employer contributions on compensation above this IRS-indexed annual cap ($360,000 for plan years beginning in 2026).

• Plan documents typically define “plan compensation” as W-2 wages, §415 safe harbor compensation, or §3401(a) wages for tax withholding purposes, subject to the §401(a)(17) cap.

Think of it as a ceiling. Once a participant’s year-to-date compensation reaches the annual §401(a)(17) dollar limit, any additional pay is disregarded for plan purposes.

How Compensation “Counts” Differently for Deferrals vs. Match

Employee Deferrals: Treated as Earned Throughout the Year

IRS guidance allows plan sponsors to treat compensation (subject to §401(a)(17)) as being earned ratably over the year in application of the annual deferral limit under §402(g) ( $24,500 in 2026).

Operationally, payroll is still deducting deferrals each pay period from actual gross pay. But when you step back at year end, you’re effectively examining total eligible compensation up to the §401(a)(17) cap and comparing that with total deferrals for the year.

For example, assume a participant earns over $1 million in compensation and reaches the annual compensation limit of $360,000 (2026 limit) by the end of March. Should deferral deductions stop after March? The IRS has noted that unless the terms of the plan dictate otherwise, deferrals continue even after the compensation limit has been reached. The results may vary if this participant has a percentage of compensation deferral election or a flat dollar election per pay period.

Scenario 1: Percentage Election

Any significant percentage election will cause a highly compensated employee to reach the deferral limit of $24,500 early in the calendar year. Following the same example with the participant earning $360,000 by the end of March, any election over 6.80% of compensation will reach the $24,500 limit by the same timeframe ($24,500/$360,000 = 6.80%).

Scenario 2: Flat Dollar Election

Assume the same participant instead elects to defer $1,020 each semi-monthly pay period and again reaches the compensation limit by the end of March. Unless the plan terms say otherwise, deferrals continue to the earlier of reaching the $24,500 limit or the last payroll date of 2026.

The majority of pre-approved plan documents provide that deferrals (and after-tax contributions) will not cease once the employee’s compensation reaches the §401(a)(17) limit, which is consistent both with the ratable treatment identified by the IRS and the reasonable expectations of most employees.

Employer Match: The Limit Must Be Followed During the Year

The same rules do not apply to employer contributions, specifically employer match that is funded on a payroll period basis. The compensation limit must be applied in real time:

• Each pay period, match is determined based on eligible plan compensation.

• Eligible plan compensation cannot exceed the §401(a)(17) limit for the year.

• Once year-to-date compensation reaches that limit, no further compensation in that year can be used to calculate the match.

Employers cannot calculate matching contributions on compensation above the §401(a)(17) cap even if the participant continues making deferrals (because the deferral limit has not yet been reached for the year). This is where many payroll systems have the potential to go wrong.

Match Calculation Example:

• The plan uses W-2 wages as eligible plan compensation, capped by §401(a)(17), which is $360,000 for 2026.

• The participant earns $650,000 in total compensation for the year.

• The match formula is 100% of deferrals on the first 4% of eligible compensation, each pay period, with no additional year-end true-up.

The participant defers the full $24,500 in 2026. The participant’s deferral percentage for applying the match is $24,500/$360,000 = 6.80%. It is NOT $24,500/$650,000 = 3.77%. Since the participant’s deferral is in excess of 4% of eligible compensation, the participant is entitled to a match of $14,400 (4% of the $360,000 compensation limit). However, that math rarely works out so nicely on a pay period basis.

Once the participant’s year-to-date compensation reaches $360,000, the system stops treating any further pay as “eligible compensation” for calculating the match. There are several issues that may arise in payroll:

1. The participant does not receive the full match he/she is entitled to receive. This can occur when a very highly paid employee elects a high rate of deferrals early in the year to “front-load” the deferrals. For example, take an employee who elects a 20% deferral rate effective January 1, 2026 and reaches the 2026 deferral limit on the March 15th pay date but has not received the full 4% match.

Without a true-up provision, there is no additional match funding for the participant, resulting in the loss of $8,983.35 in additional matching contributions that were available ($14,400 less $5,416.65). The only options to avoid this scenario are to a) communicate to employees that the match is calculated by pay period and that front-loading deferrals may result in missed match for the year, or, b) add a true-up provision in the plan document to ensure all participants receive the full match available to them based on their deferrals.

2. Payroll or service provider continues calculating the match on all compensation, ignoring the §401(a)(17) cap. The following employee elects a 4% deferral starting January 1, 2026 and does not reach the 402(g) limit of $24,500 until mid-December.

In this example, the 4% match continued to be funded each payroll period even though the maximum of $14,400 was reached mid-year. The correction in this scenario is to forfeit the excess match plus earnings so that the participant does not receive matching contributions based on compensation in excess of $360,000. Had the payroll system properly stopped the match funding in July 2026 when the total compensation earned reached $360,000, the employee would have received only the full match of $14,400, with no corrections needed.

3. Payroll calculates match separately for pre-tax, Roth, and catch-up contributions in the system. In the below example, the participant’s compensation for the payroll date is $5,000 and the matching contribution formula is 50% of deferrals up to 6% of compensation.

Pay Period Comp: $5,000

The correct match for that payroll date is $150 (6% x $5,000 x 50% = $150). If the match formula is applied to the pre-tax deferrals, Roth, and Catch-Up contributions separately, the result is $275 in matching contributions. The match calculated by source in this example therefore causes excess matching contributions. . It is important to verify that the per pay period calculations are using total deferrals divided by total compensation to determine an employee’s deferral percentage for applying the match.

BONUS CONTENT: No Match on “Catch-Up” Contributions

401(k) plans are not required to match catch-up contributions unless the plan is a safe harbor 401(k) plan utilizing a matching contribution formula to satisfy ADP Testing. Accordingly, plans that utilize a discretionary or non-safe harbor matching contribution formula may exclude catch-up contributions from the employer matching benefit. The plan terms govern whether to include or exclude catch-up contributions from the matching formula. The default is to include catch-ups unless explicitly excluded.

This may sound easy enough, but keep in mind that a deferral is not a catch-up contribution until it exceeds a statutory or plan limit.

The issue is that separate “catch-up” elections in payroll may cause an operational failure if the payroll system does not consider total deferrals up to the 402(g) limit during the plan year. Let’s review two employees making the same deferral election, but one has “elected” catch-up contributions in the payroll/recordkeeping system. The plan in this example excludes catch-up contributions from the matching formula.

Billy and Bob are both over age 50, have the same compensation each payroll, and have the same deferral elections, except that Billy has not “elected” separate catch-up contributions. Both are deferring 4% of compensation each payroll, and the company match is 100% of deferrals up to 4% of compensation.

Pay Period Comp: $5,000

Billy’s match is calculated correctly. Unless Bob’s total deferrals for the year have exceeded $24,500, Bob’s match is incorrect and he is due an additional $100. Multiply that by the number of payrolls processed in the year and that is a huge difference in matching contributions.

Assume that Bob’s total deferrals for the year never exceed $24,500. In that case, Bob does not have any catch-up contributions, and ALL of his deferrals should have been matched, INCLUDING those “elected” as catch-up. Just because the payroll system refers to an amount as a catch-up contribution does not make it so. Again, a deferral is not counted as a catch-up contribution unless and until it exceeds either a plan limit or a statutory limit (i.e., the 402(g) deferral limit).

If the payroll system does not match deferrals included in the “elected” catch-up bucket that do not exceed the deferral limit, the plan has an operational failure requiring corrections to bring the plan into compliance. We have seen this issue arise in practice, so employers need to monitor their payroll provider setup to avoid this situation.

Mandatory Roth Catch-Up contributions for high earners became effective January 1, 2026. With the ability to use the deemed Roth elections for these high earners subject to the mandate, employers may also consider eliminating the separate catch-up election. Plan sponsors continuing to use the separate catch-up election need to make sure they are correctly applying the match formula to all deferrals (whether pre-tax, Roth or separately elected catch-up) until the total deferrals for the year reach the §402(g) limit of $24,500 (2026).

Common Payroll and Recordkeeping Errors

• Match calculated on gross compensation with no cap applied. The system is told to pull “gross wages” but never applies the §401(a)(17) limit.

• Dollar cap applied for deferrals but not for match. The system correctly establishes the annual dollar limit for deferrals, but the matching formula uses a separate, uncapped compensation field.

• Bonus and off-cycle payrolls ignored. The cap isn’t monitored across all pay codes and payrolls, so match is inadvertently applied to compensation in excess of the limit after high bonuses are paid mid-year.

• Mid-year employment transfers. When employees move between related entities or payroll systems, their year-to-date compensation isn’t carried forward, so one or both systems fail to recognize when the §401(a)(17) limit is actually hit.

• Mismatch between plan document and system setup. The plan document clearly states, “compensation limited under §401(a)(17),” but the payroll or recordkeeping platform is configured using a broader, uncapped definition.

Each of these creates an operational failure to follow the plan’s compensation definition and the Code requirements.

Corrections Can Be Costly

• Forfeiture of excess matching contributions (including earnings) by affected participants.

• Plan amendments or corrective filings in more severe or long-running cases.

• Additional fees from attorneys and service providers to perform calculations, corrections, and reprocessing.

• Employee relations issues if participants see adjustments or negative corrections to prior contributions.

Catching and correcting these errors early is far less painful than discovering them in an IRS or DOL audit, or years into a recordkeeper transition.

Practical Controls to Prevent §401(a)(17) Match Errors

• Align the plan document and payroll system codes, reviewing annually before the new year starts.

• Confirm that the compensation definition in the plan document matches what payroll and the recordkeeper are actually using.

• Use a single, capped compensation field for the match in the payroll system.

• Set alerts or reports that flag employees approaching the §401(a)(17) limit.

• Confirm that once the limit is reached, the system stops counting additional compensation for match purposes.

• Verify that all relevant pay codes (bonuses, commissions, overtime, off-cycle checks) feed into the same compensation field used for match.

• Before or shortly after year-end, run a small testing sample (especially on highly compensated employees) and manually recompute:

• Year-to-date compensation subject to §401(a)(17), and

  • Matching contributions that should have been made.

• Coordinate on payroll provider transitions.

• During vendor changes, explicitly review how the §401(a)(17) limit is handled in both the old and new systems.

  • Ensure year-to-date compensation is carried over correctly so the cap isn’t effectively “reset” mid-year.

Takeaways for Plan Sponsors and Payroll Teams

• The §401(a)(17) compensation limit applies across both employee deferrals and employer contributions, but the operational timing is different.

• For deferrals, compensation is effectively treated as earned ratably throughout the year up to the cap.

• For the match, you must apply the cap in real-time, and no match should be calculated on compensation above the annual §401(a)(17) limit.

• The most effective protection is alignment between:

  • Your plan document,
  • Your payroll system configuration, and
  • Your recordkeeper’s mapping and formulas.

If you are unsure whether your payroll system is set up to handle the §401(a)(17) limit correctly, especially for matching contributions, consider performing a focused internal audit of the plan’s operations before a plan auditor or regulatory agency discovers an error.

Conclusion

Keeping payroll and plan operations tightly aligned is essential to avoiding compliance missteps and costly year-end fixes. By treating deferrals ratably, enforcing the §401(a)(17) cap in real-time for matches, and standardizing how compensation is coded and mapped, employers can significantly reduce the risk of errors. The right structure, controls, and partners will assist in establishing this area as a well-governed, predictable part of your retirement plan operations.

These retirement plan matters are complicated (and always changing), and Newfront Retirement Services team is ready to help your organization navigate the process. Feel free to contact me or just connect to keep up to date on all things ERISA 401(k): Joni_LinkedIn and 401(k)ology

Helpful Links:

• 401(k) plans - Deferrals and matching when compensation exceeds the annual limit
• 401(k) limit increases to $24,500 for 2026, IRA limit increases to $7,500
• 401(k)ology – Safe Harbor 401(k) Plans
• 401(k)ology – Impact of a Failed ADP/ACP Test
• 401(k)ology – Final SECURE 2.0 Catch-Up Regulations: Highlights to Know
• 401(k)ology – Related Employers

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The Author

Joni L. Jennings, CPC, CPFA®, NQPC™

Chief Compliance Officer, Newfront Retirement Services, Inc.

Joni Jennings, CPC, CPFA®, NQPC™ is Newfront Retirement Services, Inc. Chief Compliance Officer. Her 30 years of ERISA compliance experience expands value to sponsors of qualified retirement plans by offering compliance support to our team of advisors and valued clients. She specializes in IRS/DOL plan corrections for 401(k) plans, plan documents and plan design.

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