Compensation Waste 101 – End Unlimited Paid Time Off Accrual

In the black expanse of waste that organizations pour into ineffective compensation spending is a bright shining star — payments, typically to departing employees, for unused paid time off.  This isn’t just a waste of money when it is paid, but some accountants are now telling their clients that they may need to be accruing funds and/or reporting liabilities caused by this promise to pay in the future.  While Federal and state law must be taken into account, and legal counsel consulted before making policy changes, this is an area that of waste that should be dealt with immediately.

Paid time off exists for a valid, and important, purpose — to ensure that employees do not suffer financially when they are unable to work, or when they need a break from work.  Employers provide sick days both so that employees can take the time they need to get well without suffering financial hardship and so that they are not in the office spreading sickness to others.  Vacation is provided for different purpose – to get employees away from the stress of work, to reinvigorate them and ensure they come back to work with a better attitude.  Sometimes personal days are given to allow employees to deal with family situations, or other unplanned interruptions that could cause financial hardship.

Paid time off has never been intended to provide additional compensation — it is intended to replace possibly lost compensation.  In fact, really, beyond greed there is no justification for thinking that unlimited accrual of unused paid time off is fair.  Employers began to allow accrual in part because for some employees it was difficult to take time off, perhaps because the employer could not afford to have the employee take time off.  If that’s the case, what is the purpose of even offering the benefit in the first place?

Remember something — when you pay off unused accrued time off, you may be paying THREE TIMES OR MORE the original cost: 1) the pay that you gave the employee when they were actually working and not taking time off, 2) the pay you may have given to another employee (e.g, a temp) to cover the time off, and 3) the pay you give when you are paying off the time down the road.  Oh, and if that isn’t reason enough, consider this: most paid time off plans don’t control for when the time was earned.  Paid time off that would have cost $10 an hour thirty years ago when it was supposed to be used may well cost you more than $24 an hour when it’s paid off now (assuming 3% annual increases).   Potential worst case scenario?  $322 (plus taxes) now for what would have cost $80 or $160 in the first place.

With increasing scrutiny of executive compensation, consider what unlimited accrual might look like for a retiring executive.  Let’s assume a CEO who started out right after college, moved up the ranks and was the CEO for 20 years prior to retirement, and managed to take only two weeks of vacation a year.  Let’s further assume a fairly typical vacation plan that maxes out at 5 weeks per year after 20 years of employment, and that the executive was competitively, but not excessively, compensated.   Paid out at the final hourly earnings of the executive, it would be reasonable to expect that you’ll be paying, and reporting on your Form 990, somewhere between $400,000 and $450,000 in vacation time.  Assume half of the maybe twelve personal and sick days allowed are unused, and you can tack on another quarter of a million .  Even though you are just following an approved policy that affects every employee equally, how is this going to look?  What is the reporter going to say to this “golden handshake” that might just make your CEO the highest paid employee reported in an FQHC that year?  I might be able to defend it to the IRS, but I’d just as soon not find out.

Check with your employment attorney before you do anything (particularly if you’re in California), but to the extent you can, consider doing the following:

1. Stop your policy of unlimited accrual.  If you’re not willing (or unable) to go to a “use it or lose it” approach (perhaps with the exception of accrual where the employer does not allow the employee to take time off), then at least limit the amount of vacation that can be in the “bank” at any time.  Perhaps allow the bank, at any time, to be equal to one year’s accrual.

2. If it is established that the unused paid time off has actually been “vested,” and is owed to employees, start the process of paying it off now and over time to reduce the employees’ bank to whatever your new banking limit (if any) is.  If allowed, pay this time off at the rate at which it was earned, not at the current wage or salary.

3. Start planning, and developing resources, to ensure that vacation and other time off can be taken, and make it a priority of managers to ensure that it is taken.  Do not allow the ability to accrue make up for the sin of poor planning.

Whether times are tough or not, no organization can afford additional cost that provides no additional value.  Fiduciary responsibility demands it.