The $360,000 compensation cap is not a staff-cost cap

The compensation cap is the limit owners remember, and the limit they misapply. For 2026 a qualified plan may not take into account more than $360,000 of any one participant's compensation. The figure comes from section 401(a)(17), it was published with the other cost-of-living adjustments in IR-2025-111 on November 13, 2025, and the technical detail is in Notice 2025-67. Last year the cap was $350,000. The IRS keeps the current table on its cost-of-living adjustments page. The cap limits what the formula can see. It does not limit what you must contribute for employees. A staff-cost estimate that treats $360,000 as a ceiling on the employee side of the budget is using the wrong ceiling.

Sterling Pension Group LLC in West Hartford is a third-party administrator. We are not an actuarial firm. Independent Enrolled Actuaries certify valuations and the cost of a formula. This briefing is not tax, legal, or actuarial advice. It separates two ideas that slide decks tend to merge.

What the cap does

The plan's formula for benefits, allocations, and much of the deduction arithmetic uses capped compensation. An owner paid $900,000 is, for those purposes, paid $360,000. Raising W-2 wages from $400,000 to $700,000 does not increase the pay the cash balance formula can use. It increases employment tax and the cash leaving the company. If the wage is already at the cap, the lever that remains is the formula, the owner's age, the benefit limit, and the staff census. It is not a larger W-2.

The same cap applies to a staff member, and for almost every staff member it never bites. A coordinator paid $70,000, a hygienist paid $95,000, an associate paid $180,000, are all under $360,000. The plan sees all of their pay, if the document's definition of compensation includes it. There is no special staff cap at a lower number. There is one statutory cap, and it is high enough that it is an owner provision in every practical sense.

The cap also limits the compensation base used when someone speaks in percentages. Six percent of pay, as a profit-sharing shape, is six percent of capped pay. Six percent of $360,000 is $21,600, not six percent of an uncapped draw. Twenty-five percent is computed the same way. A staff member's percentage is a percentage of the staff member's actual considered pay, which is simply their pay. Mixing the owner's uncapped collections into a "percentage of payroll" is how staff cost gets quoted as a comforting small number and arrives as a large one.

Publication 560 states the compensation limit next to the other limits, which is the right neighborhood. The defined contribution annual-additions limit is $72,000. The elective deferral limit is $24,500, with catch-up of $8,000, or $11,250 at ages 60 through 63. Catch-up sits outside the additions limit. The defined benefit limit is an annual benefit of $290,000, not a contribution, and the IRS explains it on the benefit limits page. None of those is a cap on the sum of staff contributions. A plan can be well inside every one of those ceilings and still have a staff cost you dislike. The ceilings are per participant, or they are benefit ceilings. They are not a firm-wide discount.

What the cap does not do

It does not exclude employees. Eligibility is age, service, hours, and the exclusions the document is allowed to use. Being paid less than $360,000, which is nearly everyone, is not an exclusion. A plan that covers only owners in a firm that employs a full staff will fail coverage or nondiscrimination or both, and the cap will not be the reason it passes.

It does not freeze staff cost at last year's dollar. Last year's cap was $350,000. The move to $360,000 slightly increases the maximum considered pay for an owner who is over the cap. It does almost nothing to the cost of a percentage formula for employees under the cap. Their cost moves when their wages move, when headcount moves, and when the formula moves. A 4 percent raise for a $90,000 employee is a staff-cost event. The COLA adjustment on the owner's cap is not the event that explains it.

It does not put a maximum on the employer's deduction equal to $360,000. The deduction for a defined benefit contribution is actuarial, subject to the funding rules and to section 404. The deduction for defined contribution employer contributions is generally limited to a percentage of compensation, with the participant-level additions cap beside it. Both calculations use capped compensation as an ingredient. Neither one says the firm may deduct only $360,000 in total, and neither one says the firm may deduct $360,000 per owner as a cash balance deposit. There is no flat IRS cash-balance contribution cap. An illustrative deposit above $360,000 can be lawful for an older owner because the limit that binds is the $290,000 annual benefit, converted by the actuary into a contribution. An illustrative deposit far below $360,000 can be the most the same firm can do once staff are tested. The cap is not the sorting tool. The illustrations page exists so those deposits stay labeled as illustrations.

It does not reduce the gateway or the staff benefit to a percentage of the cap. Where a combo design uses a gateway contribution so a cross-tested arrangement can satisfy the regulations, the gateway is a percentage of each non-highly compensated employee's own pay. The common figures discussed in designs are a matter of the regulation and the document, not a universal tax. If someone tells you "staff cost is 7.5 percent of the cap," ask them to restate it as a percentage of eligible staff payroll and to show the census. Those sentences will not match. The staff cost page is the one to keep open during that conversation.

Where staff cost actually comes from

It comes from who is eligible. A one-year wait and a 1,000-hour rule keep a large share of turnover out of the plan. Immediate eligibility brings them in. The document already made this choice. The cap does not remake it in July. If you are hiring, the hiring briefing is the census warning. The cost of a new eligible employee is the benefit the formula gives that employee, plus any profit-sharing or gateway the combo requires, plus the effect on whether the owners' credits still pass.

It comes from the formula. A cash balance plan tested on benefits can direct a larger share of the economic value to an older owner than a flat percentage SEP can. That is the design advantage. The advantage is not zero staff cost. Employees who benefit still receive a real pay credit or a real profit-sharing contribution. A design that shows the owner an illustrative six-figure credit and shows staff as an afterthought has not finished the illustration. Ask for the staff line in dollars, on this year's eligible payroll, before you adopt the owner line.

It comes from highly paid employees who are not owners. An associate earning $250,000 is under the cap, so the entire $250,000 counts, and a percentage formula on that pay is expensive. The same person may be highly compensated, which changes which side of the test they sit on. A formula that was cheap when the only non-owner employees earned $60,000 is a different formula when the non-owners include a clinician. The cap did not cause that. The offer letter did. Sector pages for physicians, dentists, and consultants are useful only if the census matches the sector. A consultant with no employees and a physician with twelve employees are not in the same staff-cost conversation, and the $360,000 cap will not put them there.

It comes from the compensation definition. Overtime, bonuses, and certain deferrals may or may not be included, depending on the document. A bonus paid to staff increases the base if the definition includes bonuses. Calling the bonus a gift, or paying it outside payroll, is not a plan strategy. It is a payroll problem and often an employment-tax problem. The definition you adopted is the definition the test will use.

Top-heavy minimums, if they apply, are another staff cost that the cap does not mute. They are a minimum allocation or benefit for non-key employees when key employees hold most of the value. They are computed on the employee's pay. An owner already at the compensation cap can still trigger a top-heavy minimum for a $55,000 employee. The minimum is not computed on $360,000 for that employee. It is computed on $55,000.

A clean way to read a staff-cost quote

Ask for four numbers, and do not accept a percentage by itself. Eligible payroll, with each person at considered compensation and no one above $360,000. The dollar of staff cash balance credits. The dollar of staff profit sharing or gateway. The dollar of owner credits, labeled illustrative. The ratio of staff dollars to owner dollars is the quote. A percentage of "total payroll" that includes the owner's uncapped collections, or that excludes half the eligible staff, is not the quote.

Then ask what happens if one more eligible employee is hired at a stated salary. The marginal cost is the number that belongs in the hiring decision. The cap will not change that marginal cost unless the new person is paid more than $360,000, which is a different hire from the one most practices are considering.

Roth catch-up does not change staff cost either, but it changes a high earner's 401(k) election. If prior-year FICA wages exceeded $150,000, the catch-up generally has to be Roth in 2026. The rule applies to the 401(k) catch-up. It does not apply to cash balance pay credits, owner or staff. Ask the recordkeeper. Final regulations are stricter in 2027. This year is good-faith operational compliance. It is not a reason to restate the compensation cap.

PBGC coverage is also not the cap. Many small professional-service plans are exempt. Not all. The exemption looks at the employer and at active-participant headcount, generally not more than 25. Staff you already employ are the headcount. The PBGC coverage page is the reference. Premiums, where they apply, are a cost per participant. They are still not the compensation cap.

What to do in the next two weeks

Pull considered compensation, year to date and projected, for every person who might be eligible. Cap any figure above $360,000 at $360,000 before you send it. Do not cap anyone else.

Ask for the staff cost in dollars on that census, next to the illustrative owner credit. If the quote you already have is a percentage, send it back for translation. Compare it with cash, not with the owner's gross collections.

If the resulting staff dollar changes whether you want the plan, say so in July, when a formula that has not yet been fully accrued may still be amendable. Do not wait for the contribution to harden and then call the cap a defect. Then send the capped census. The useful page is a list of people and pay, not a single capped owner and a shrug about everyone else.