According to U.S. Bureau of Labor Statistics, American employees constantly underutilize their vacation days and other paid time off (PTO).
Over half of them (57%) carry forward their sick days to the following year, and 53% do the same for vacation days.
As a result, companies accumulate a substantial liability due to unused vacation time and have to employ various strategies to manage it.
One is PTO buyback, a practice offering employees an additional opportunity to utilize their accrued time off and helping businesses improve financial flexibility and cost control.
In this blog post, we will delve deeper into this benefit, its associated pros, cons, and legal aspects.
Understanding PTO Buyback
The concept of PTO buyback emerged in the 1970s in the United States. Such programs allowed employees to exchange their accrued but unused PTO for monetary compensation at the end of the year or during specific periods.
The PTO types to be “cashed out” included vacation days, personal days, and sometimes sick leave. However, the number of such days was usually subject to a maximum limit set by the employer or state law.
As more employers recognized the advantages of the new approach, the PTO plan gained popularity and became a common workplace benefit across various industries by the 1980s.
Over time, the program has undergone evolution, incorporating different variations. Some adaptations include enabling employees to carry over unused vacation time to the following year or to donate their surplus time to a colleague in need.
But still, PTO buyback has advantages and disadvantages that should be carefully considered.
For example, employers can budget more accurately when they know they will pay out unused time off. However, buyback creates financial liability for the company, especially if many employees opt for it simultaneously.
Regarding employees, the buyback offers additional income to cover unexpected expenses or emergencies but can lead to burnout and decreased work-life balance.
Calculating PTO Buyback
The calculation for PTO buyback is relatively straightforward.
Determine the employee’s hourly wage.
Multiply the number of unused PTO hours by the employee’s hourly wage to arrive at the total amount to be paid out.
Example:
In 2024, John was granted a total of 21 days of paid time off (PTO), but he only took 10 days throughout the year. As a result, she had 11 days of unused PTO remaining.
Given that John’s daily rate of pay for PTO is $120, his PTO buyback value is calculated by multiplying the number of unused days (11) by his daily rate of pay ($120). Therefore, John’s PTO buyback amount is $1320.
Adjustment for Taxes
In most states, PTO buyback is treated as taxable income for the employee.
This means the the payment for unused PTO must be reported on their W-2 (or other applicable) form. The employer will withhold taxes from the payment based on the employee’s withholding allowances and tax bracket, as shown below.
22% is the Federal Income Tax.
This bonus can be structured as a tax-free incentive, significantly assisting employees in alleviating their student debt. Through this initiative, an employer can offer up to $5,250 per employee annually, free from taxation.
0.78 is the adjustment for taxes (considering a 22% tax rate)
Hourly wage is the annual salary divided by the the standard number of working hours in a year for a full-time employee based on a 40-hour workweek for 52 weeks.
PTO Buyout Cap
Depending on the PTO policy, there may also be a PTO buyout cap, which limits the maximum amount of paid time off that an employee can “sell” to the company.
The employer typically outlines this cap in the company’s policies or employment contracts.
For example, an employer might have a PTO buyout cap of 40 hours, meaning that an employee can only receive payment for up to 40 hours of unused PTO when they leave the company or at the end of the year, regardless of how much PTO they have accrued beyond that limit.
Laws Regulating PTO Buyback
The regulations regarding PTO buyback vary by jurisdiction and are often determined by employment laws at the state or national level.
In some locations, there may be requirements for employers to compensate employees for unused PTO upon termination or resignation, while in others, it may be at the employer’s discretion.
In the United States, no federal law mandates PTO buyback.
However, some states have laws that require employers to pay out accrued but unused PTO upon termination or resignation. Here are some examples:
- California. If an employee’s employment ends, any unused vacation time earned cannot be taken away unless specified in a collective bargaining agreement. Vacation pay that has been accrued and is “earned and determinable” must be paid out.
- Colorado. The determination of when vacation pay is considered “earned” depends on the agreement between the employer and employee. If there is no clear agreement, factors such as past practices, industry standards, mutual understanding, and other relevant considerations will be taken into account.
- Kentucky. Employers must compensate departing employees for any accrued and unused vacation pay if they offer “vested vacation pay,” regardless of whether the employee is terminated or leaves voluntarily. However, employers are not obligated to compensate for vacation time not vested under a policy or contract.
Vested vacation pay is treated as wages, but the timing of when it vests is determined by the employer-employee policy or contract.
- Maine. For private employers with 10 or more employees, any accrued vacation pay owed must be settled upon an employee’s termination. It’s important to note that vacation time is not included in final paycheck requirements.
- North Dakota. Upon termination, employers must pay departing employees for earned paid time off (PTO) at the regular rate of pay that was earned before separation. Employment policies or agreements cannot include the forfeiture of earned PTO upon separation.
However, if an employee voluntarily leaves their job, a private employer may withhold payment for accrued PTO under certain conditions. These conditions could include providing written notice about limitations on payment of accrued PTO at the time of hiring or if the employee has been employed for less than one year and provided less than five days’ notice.
- Rhode Island. After one year of service, employers must compensate separated employees for their accrued vacation time based on a collective bargaining agreement, company policy, or any other agreement between the employer and employee.
- Utah. Employers must compensate employees for any accrued and unused leave upon termination unless the employer has explicitly implemented a use-it-or-lose-it policy stating that leave does not accumulate and employees are not paid for unused leave.
In the European Union, the Working Time Directive sets minimum requirements for paid annual leave, but rules regarding PTO buyback can vary by country.
Employers are generally required to provide paid vacation time, but the specifics of PTO buyback may be outlined in employment contracts or collective bargaining agreements.
Implementing a PTO Buyback Program
While PTO buyback has advantages and disadvantages, it’s a compelling option for companies aiming to create a more flexible and employee-centric work environment.
And a well-designed PTO buyback program will help you make the most of it. Here’s a step-by-step guide to help you launch one.
- Find out your employees’ needs and preferences. Consider conducting surveys or focus groups to gather feedback on the types of benefits they value most, including their interest in a PTO buyback program.
- Determine the specific details of your PTO buyback program, such as which types of leave (e.g., vacation, sick days) are eligible for buyback, the maximum number of days that can be cashed out per year, and the payment calculation method (e.g., at the employee’s regular rate of pay).
- Develop clear policies and guidelines outlining how the PTO buyback program works, including eligibility criteria, application procedures, deadlines for submitting requests, and any limitations or restrictions.
- Communicate the details of the PTO buyback program to employees clearly and transparently. Use multiple channels, such as email, company intranet, and staff meetings, to ensure that all employees are aware of the program and understand how it works.
- Consult with legal and HR professionals to ensure that your PTO buyback program complies with federal, state, and local labor laws, as well as any collective bargaining agreements or company policies.
- Establish an efficient process for employees to request and receive payment for their unused PTO. This may involve setting up an online portal or form for submitting buyback requests and coordinating with payroll to ensure the timely processing of payments.
- Regularly monitor the usage and impact of your PTO buyback program to assess its effectiveness. Collect employee feedback on their experience with the program and make adjustments to improve its success.
- Emphasize the importance of work-life balance and encourage employees to use their PTO for rest. While a PTO buyback program can provide financial benefits, it’s essential also to promote the value of taking time off to recharge and prevent burnout.
