How 401(k) Deferrals Move Through Payroll, From Eligible Pay to Annual Limits
A 401(k) deferral is the portion of an employee’s pay that is withheld on payday and contributed to the retirement plan. Payroll handles it in the same six steps every cycle.
1. Identify the pay that counts as eligible compensation under the plan.
2. Apply the employee’s deferral election to that pay.
3. Split the deferral between pre-tax and Roth contributions.
4. Withhold taxes on the correct base.
5. Track year-to-date deferrals against the annual limit.
6. Report the totals on the employee’s Form W-2.
This guide covers federal rules for tax year 2026, with every figure as of October 6, 2026. It is general information, not tax or legal advice, so confirm plan-specific details with your plan administrator or tax advisor.
What Counts as Eligible Pay
The plan document defines eligible pay. The IRS tells plan sponsors to follow the compensation definition in the plan document, and a plan can include or exclude items such as bonuses, overtime, and commissions. A professional services firm with year-end bonuses and a restaurant or construction employer with heavy overtime face different versions of the same decision.
Every pay code in payroll, from regular wages to overtime to commissions, has to be mapped to that definition. The IRS treats a gap between the written definition and how payroll actually operates as a plan error to correct. An employer match, where a plan has one, is a calculation that runs on eligible pay as the plan defines it.
For 2026, the IRS caps the compensation a plan can take into account at $360,000 when it determines employer and employee contributions, per IRS Notice 2025-67 and the IRS 401(k) contribution limits page (as of October 6, 2026).
How Pre-Tax and Roth Deferrals Work on a Paycheck
A pre-tax deferral is left out of the wages used for federal income tax withholding. A Roth deferral comes out of pay that is already included in income. When a plan has a Roth option, an employee can elect Roth contributions in place of pre-tax deferrals, per the IRS General Instructions for Forms W-2 and W-3.
The two types are taxed differently and reported under separate W-2 codes, so payroll carries them as separate deductions. Both count toward one shared annual limit.
Are 401(k) Deferrals Subject to Payroll Taxes?
Pre-tax deferrals are generally exempt from federal income tax withholding, but they remain subject to Social Security, Medicare, and Federal Unemployment Tax Act (FUTA) taxes, per IRS Publication 15 (2026), section 15.
Roth deferrals are subject to federal income tax withholding and to Social Security and Medicare taxes, per the IRS retirement plan contribution withholding guidance (updated August 4, 2026).
How Deferrals Appear on the W-2
Per the 2026 IRS General Instructions for Forms W-2 and W-3, pre-tax deferrals are excluded from Box 1 (wages, tips, other compensation) but included in Box 3 (Social Security wages) and Box 5 (Medicare wages and tips). Box 12 reports them under code D for a 401(k), and the retirement plan box in Box 13 is checked.
Roth deferrals are included in Boxes 1, 3, and 5, and Box 12 reports them separately under code AA.
What the 2026 Limits Are
As of October 6, 2026, these are the 2026 figures in IRS Notice 2025-67 for 401(k) plans other than SIMPLE 401(k) plans, which have lower limits.
Limit
2026 amount
What it applies to
Elective deferral limit
$24,500
Pre-tax and Roth deferrals combined, per person
Catch-up, age 50 and older
$8,000
On top of the deferral limit, if the plan permits
Catch-up, ages 60 through 63
$11,250
Replaces the $8,000 catch-up for people who turn 60, 61, 62, or 63 in 2026
Compensation cap
$360,000
Pay a plan can count for contributions
People who are 50 or older at the end of the calendar year can make catch-up contributions, per the IRS catch-up contributions page. In a plan that permits them, an eligible employee can defer up to $32,500 in 2026, and one who turns 60, 61, 62, or 63 in 2026 can defer up to $35,750. Deferrals above the 2026 limit of $24,500 count as catch-up contributions only for eligible employees in a plan that permits them.
Starting in 2026, catch-up contributions must be made as Roth contributions for a participant whose FICA (Social Security and Medicare) wages from the employer that sponsors the plan exceeded $150,000 in the prior calendar year, per Notice 2025-67 and the IRS catch-up contributions page (as of October 6, 2026). For 2026 catch-ups, the test uses 2025 wages. The final regulations apply to tax years beginning after December 31, 2026, and a reasonable, good-faith interpretation standard applies for 2026.
How to Keep Deferrals Under the Limit During the Year
The limit is a running total. Before each payroll, the most an employee can defer is the annual limit minus year-to-date pre-tax and Roth deferrals, plus any catch-up room the employee qualifies for. Each deferral has to be tested against that remaining amount before the paycheck is final.
Bonuses need their own check. When the plan counts bonuses as eligible pay, a percentage election applies to the bonus as well, and on a large bonus it can push year-to-date deferrals past the limit in a single cycle.
If an employee’s deferrals go past the limit without qualifying as catch-up contributions, the excess needs correcting, and the plan’s administrator handles the correction, per the IRS guidance on deferrals across plans.
Does the Limit Follow an Employee Across Two Employers?
Yes. The deferral limit is an individual limit for each calendar year, and the IRS requires deferrals to be combined across 401(k), 403(b), and SIMPLE plans, among others, no matter how many plans the person is in (page last reviewed February 26, 2026).
A payroll system sees only the deferrals from its own employer. An employee with a second job or a mid-year job change should track the combined total and notify the plan when it passes the limit.
Where AsureCentral Payroll and Asure 401(k) Plans Fit
AsureCentral is a unified payroll and HR platform with one login and personalized dashboards, supporting payroll, HR, tax, benefits, recruiting, time, employee self-service, and settings, with role-based access plus implementation and support. Asure 401(k) Plans are payroll-integrated retirement plans with automatic contributions through payroll, plan monitoring, required filings, and compliance support to offer competitive benefits for smaller employers. They are sold as an add-on to AsureCentral.
Whichever system runs payroll, these are the checks an employer or its payroll provider has to get right.
* Match every pay code to the plan document’s compensation definition.
* Set up pre-tax and Roth as separate deductions that share one annual limit.
* Test every deferral, bonuses included, against year-to-date deferrals before payroll finalizes.
* Confirm catch-up eligibility by age and plan permission, along with the 2026 Roth catch-up wage test.
* Reconcile Box 12 codes D and AA at year-end.
Owners and CFOs adding or modernizing a retirement plan with payroll integration can use this list as a setup and audit checklist. If you are adding a plan or auditing how deferrals run through payroll, schedule a conversation with Asure about AsureCentral payroll and Asure 401(k) Plans. To go further, read How to Offer a 401(k) Plan to Employees.
