Elective Deferral

An elective deferral is an amount an employee elects to have an employer contribute to a workplace retirement plan out of compensation the employee could otherwise have taken in cash. Internal Revenue Code section 402(g), the provision that caps them, is headed "Limitation on exclusion for elective deferrals," and section 402(g)(3) defines the term as the sum of four specific items: a 401(k) contribution made under a qualified cash or deferred arrangement; an amount an employee elected into a simplified employee pension under the salary-reduction arrangement known as a SARSEP, which the definition reaches by cross-reference to section 402(h)(1)(B); "any employer contribution to purchase an annuity contract under section 403(b) under a salary reduction agreement"; and "any elective employer contribution under section 408(p)(2)(A)(i)," which is the SIMPLE plan version. An ordinary employer-funded contribution to a simplified employee pension is not an elective deferral, because no employee elected anything.

The naming deserves a moment, because at least four names circulate for the same act. Elective deferral is the tax code's term and the one on IRS pages. Salary deferral is the common informal name and means the same thing. Salary sacrifice is the British and Australian term and appears nowhere in United States regulation, so an American plan document will not use it. And pre-tax contribution is not a synonym but a description of one of the two flavors: a designated Roth deferral is equally an elective deferral and is not pre-tax. The Treasury regulations add their own vocabulary, calling the employee's decision a "cash or deferred election" and the resulting money an "elective contribution."

The mechanism that makes a deferral work is that the money is never yours to receive. 26 CFR 1.401(k)-1(a)(3)(i) defines a cash or deferred election as "any direct or indirect election (or modification of an earlier election) by an employee to have the employer either" provide the amount "in the form of cash (or some other taxable benefit) that is not currently available" or "contribute an amount to a trust, or provide an accrual or other benefit, under a plan deferring the receipt of compensation." The phrase carrying the weight is "not currently available," and the regulation states the requirement separately at (a)(3)(iii)(A): an election can only be made with respect to an amount not currently available to the employee. That is why a deferral is not taxed now. It is not a deduction for money you received; it is money you arranged not to receive. A reader who has already been paid cannot retroactively defer it.

Automatic enrollment is still an election, which surprises people. The same regulation, at (a)(3)(ii), says that in deciding whether an election exists "it is irrelevant whether the default that applies in the absence of an affirmative election" is cash or a plan contribution. So an employee auto-enrolled at three percent who never filled in a form has made an elective deferral in the eyes of the Code, with the same tax treatment and the same limit.

The Code calls the employee's own money an employer contribution, and that is why the paperwork reads oddly. Every one of 402(g)(3)'s four items is worded as an "employer contribution," because mechanically the employer is the party that pays the money into the plan. Plan statements, testing reports and disclosures follow the statute, so an employee can find their own deferrals described as employer contributions in a document that also uses "employer contribution" to mean the match. The distinction to hold onto is that a deferral is the employee's pay, whatever the document calls it, while a true employer contribution such as a match is additional money.

A Roth deferral is an elective deferral, so the two flavors share one limit. IRC 402A(a)(1) provides that "any designated Roth contribution made by an employee pursuant to the program shall be treated as an elective deferral for purposes of this chapter, except that such contribution shall not be excludable from gross income." The consequence is spelled out at 402A(c)(2), which caps the amount designated as Roth at the maximum excludable elective deferrals for the year less the deferrals not so designated. In plain terms, choosing Roth changes when the money is taxed and buys no extra room. Splitting a year's deferrals between pre-tax and Roth divides one allowance; it does not create two.

The payroll-tax point, stated precisely, because it is the fact people get wrong. A pre-tax deferral is excluded from wages for income tax and is not excluded from Social Security and Medicare wages. IRC 3121(v)(1)(A) says so directly: nothing in the wage exclusions "shall exclude from the term 'wages'" any 401(k) employer contribution not included in gross income by reason of section 402(e)(3) "or consisting of designated Roth contributions." The Code then does the same thing to each of the other three deferral types, by carving the deferral out of its own plan's exclusion: 3121(a)(5)(C) excludes simplified employee pension payments "other than any contributions described in section 408(k)(6)"; 3121(a)(5)(D) excludes 403(b) annuity payments "other than a payment for the purchase of such contract which is made by reason of a salary reduction agreement"; and 3121(a)(5)(H) excludes SIMPLE arrangements "other than any elective contributions under paragraph (2)(A)(i) thereof." Four provisions, one result: every elective deferral is Social Security and Medicare wages. The practical reading is that a deferral defers income tax only, and the payroll tax on it has already been paid, which is a meaningful contrast with a pre-tax health premium under a cafeteria plan.

A 457(b) plan is deliberately outside all of this. The four-item list in 402(g)(3) does not include a section 457 plan, and the IRS states the aggregation rule the same way: the limit "must be aggregated for these plan types: 401(k), 403(b), SIMPLE plans (SIMPLE IRA and SIMPLE 401(k) plans), SARSEP," and separately, "if you're in a 457(b) plan, you have a separate limit that includes both employee and employer contributions." The two limits have carried the same dollar figure in recent years, which is why they are so often described as one, but they are two limitations under two Code sections and the IRS announces them in separate sentences. Someone eligible for both plans can therefore use each in full, which is a genuine and substantial planning difference rather than a technicality.

A second ceiling nobody mentions until it binds: your own pay. The IRS states that the most that can go into a plan is the lesser of the annual limit for that plan type or "100% of your eligible compensation defined by plan terms." For a full-time worker earning well above the limit this never matters. For a part-time worker, someone with a partial year of employment, or a self-employed person with thin net earnings, it is the operative cap, and the annual dollar figure is irrelevant. The dollar limits themselves, the catch-up amounts, and the rules for tracking a limit across two employers in the same year all belong with the contribution limit entry.

An employee tells the plan what portion of future pay to divert, as a percentage or a dollar amount, and whether it should be pre-tax or Roth. Payroll withholds it from each paycheck before computing income tax withholding on the pre-tax portion, and sends it to the plan. The employer, not the employee, is the party that makes the contribution, which is how the statute describes it.

A hypothetical example, using one pay period so the tax lines are visible. Dara's gross pay for a pay period is $4,000. Assume a 22 percent marginal income tax rate for the illustration, and the employee shares of Social Security and Medicare tax, 6.2 percent and 1.45 percent, which together are 7.65 percent.

With no deferral: income tax of 22 percent on $4,000 is $880, and Social Security and Medicare tax is $4,000 × 7.65% = $306.00. Take-home is $4,000 − $880 − $306.00 = $2,814.00.

With a $400 pre-tax deferral: the $400 is excluded from wages for income tax, so income tax is 22 percent of $3,600 = $792. Social Security and Medicare tax is still computed on the full $4,000, so it stays at $306.00. Take-home is $4,000 − $400 − $792 − $306.00 = $2,502.00. The $400 that went into the plan cost her $2,814.00 − $2,502.00 = $312.00 of spendable pay, because $88 of income tax was deferred with it. The $30.60 of Social Security and Medicare tax attributable to that $400 was still charged.

With a $400 designated Roth deferral instead: the $400 is included in income, so income tax is 22 percent of the full $4,000 = $880, and payroll tax is again $306.00. Take-home is $4,000 − $400 − $880 − $306.00 = $2,414.00. The Roth version costs the full $400 of spendable pay, $88 more than the pre-tax version, and that $88 is precisely the income tax the pre-tax version postponed.

Both $400 amounts count against the same annual limit, which for 2026 is $24,500 across the plan types section 402(g) aggregates. Splitting a year between the two flavors divides that one allowance rather than doubling it.

Pros

• A pre-tax deferral reduces the wages income tax is computed on in the year it is made, so the cost to spendable pay is less than the amount saved.
• The money is invested inside a plan where it grows without annual tax on dividends, interest or realized gains.
• It is usually the trigger for an employer match, which is separate money and does not count against the deferral limit.
• Payroll withholding makes it automatic, and automatic enrollment counts as an election, so the default itself is a working deferral.
• The pre-tax and Roth choice is a real lever: the same election can be split, and the split can be changed for future pay.

Cons

• It does not reduce Social Security and Medicare tax, so the payroll-tax saving many people expect does not exist.
• Choosing Roth buys no additional room. The two flavors share one limit.
• An election only reaches pay not yet available, so a bonus already received cannot be deferred after the fact.
• Deferred money is inside a retirement plan, with the withdrawal restrictions and penalties that come with it, so it is not emergency savings.
• The limit follows the person rather than the employer, and no payroll department can see another one's deferrals, so tracking in a job-change year is the employee's problem.
• A pre-tax deferral defers income tax rather than avoiding it, and the rate that will apply on withdrawal is not knowable in advance.