What is the compensation limit for retirement plans?

The limit and what it is for

Retirement plans are meant to help a broad group of workers, so the tax law limits how much pay counts when employer contributions are calculated. Publication 560’s What’s New section gives the figures: $350,000 for 2025 and $360,000 for 2026. If a participant earns more, the excess pay is ignored when you figure the contribution that is a percentage of pay.

Do not confuse it with other dollar limits in the same publication. The defined contribution limit ($70,000 for 2025; $72,000 for 2026) caps what can go in. The elective deferral limit ($23,500 for 2025; $24,500 for 2026) caps what the employee can defer. The compensation limit caps the pay that percentage formulas can use.

Where the limit applies

In a SEP, you cannot consider the part of an employee’s compensation over $350,000 when figuring your contribution limit for that employee (2025), and the SEP contribution itself is capped at the lesser of 25% of compensation or $70,000. In a SIMPLE IRA plan, only $350,000 of compensation is taken into account to figure the 2% nonelective contribution in 2025 ($360,000 in 2026). In a qualified plan, no more than $350,000 can be taken into account for contributions other than elective deferrals in 2025, and the same cap applies in figuring the 25% deduction limit for profit-sharing plans. The same amount also appears in step 6 of the self-employed deduction worksheet, as $350,000 times the plan rate.

Where it does not apply

The compensation limit does not stop an employee from deferring up to the elective deferral limit, because in a 401(k) plan elective deferrals are separate from the percentage-of-pay formulas. The deduction rules say that elective deferrals are not subject to the 25% deduction limit while compensation for that limit includes elective deferrals, and the compensation limit still applies to each employee. Catch-up contributions are also outside the defined contribution dollar limit.

Worked examples

An employee earned $200,000 in 2025 under a SEP. The compensation limit does not bite. A 25% contribution would be $50,000, which is under the $70,000 maximum.

An employee earned $450,000. Only $350,000 counts. A 25% contribution on $350,000 would be $87,500, but the $70,000 maximum applies, so the SEP contribution is $70,000. Switch to a 2% nonelective SIMPLE contribution and the figure is 2% of $350,000, or $7,000, rather than 2% of $450,000, or $9,000. The calculator shows the capped pay, the amount ignored, the maximum SEP contribution and the 2% figure.

A careful note on the publication’s own SEP example: it says an employee who earned $260,000 in 2025 can have only $70,000 contributed. But 25% of $260,000 is $65,000, so under the 25% rule the limit would be $65,000, not $70,000; $70,000 becomes the binding limit only when 25% of capped pay exceeds it, which is at $280,000 of pay. Use the 25% rule as written and confirm with your plan provider.

What counts as compensation

Chapter 1 explains that compensation for plan allocations is the pay a participant received from you for personal services, generally including wages and salaries, fees for professional services, commissions, tips, fringe benefits and bonuses. For a self-employed individual it means the individual’s earned income. It generally includes amounts deferred at the employee’s election in 401(k), 403(b), SIMPLE IRA, SARSEP, 457 and cafeteria plans, though an employer may choose to exclude those deferrals. It can generally not include nontaxable reimbursements or deferred compensation other than elective deferrals. As alternatives, you may use W-2 box 1 wages, wages for income tax withholding, or Social Security wages. SIMPLE plans use a special definition covered on our SIMPLE coverage page.

Highly compensated employees are a different number

The publication also defines a highly compensated employee as someone who owned more than 5% of the business in the current or preceding year, or received more than $155,000 of compensation for the preceding year if that year is 2024, and the amount increased to $160,000 for 2025 and 2026. That is a testing threshold, not the same as the $350,000 plan compensation limit.

Sources

• IRS Publication 560, Retirement Plans for Small Business (SEP, SIMPLE, and Qualified Plans) (2025): What's New (Compensation limits for 2025 and 2026); Chapter 1 (Compensation); Chapter 2 (Contribution Limits, Annual compensation limit); Chapter 3 (Nonelective contributions); Chapter 4 (Employer Contributions; Deduction Limits; Elective Deferrals). Read November 2, 2026.

Edition read: Publication 560 (2025), for use in preparing 2025 returns. Where the publication gives 2026 figures, this page labels them 2026. Dollar limits change every year; check the current publication and form instructions for your plan year. This page summarizes the publication and does not replace it.