Leave: Can We Change Our Policy to Limit Carryover of Accrued PTO Time?

We thought managing PTO was going to be easy, but we’ve found some problems with carryover of PTO hours. We currently allow unlimited carryover, but that’s going to cause some problems down the road (like three-month vacations). So we’d like to limit carryover. Is there a carryover rule? We really want to force employees to take their time during the current year. If we make it clear that they have to use the time or lose it, are we OK? (We’d make an exception, allowing carryover for scheduled absences in the following year, but the employee would lose the leave time if he or she did not take the scheduled vacation).
— Ronald, HR Manager in Sacramento

There is good news and bad. The bad news is that California has specific vacation pay rules that limit your options. The good news is that some very good options are still available.

The starting point is that vacation time (including paid time off (PTO) or any other paid time off that the employee can use for any reason, regardless of what you call it) is considered wages. You do not have to provide paid vacation or PTO, but if you do, it is an earned vested benefit that cannot be forfeited. You therefore cannot legally adopt any type of “use it or lose it” policy; vacation and PTO must be accrued on a pro rated basis throughout the year, and any unused time must be paid out when employment ends.

However, there are several strategies for limiting your liability. You can and should adopt a ceiling on PTO accrual. You could distinguish between vacation and sick time, or you could manage your employees’ use of vacation time more effectively. Or, if you want to avoid California law altogether, you could adopt a qualified federal Employee Retirement Income Security Act (ERISA) plan for vacation.

Ceiling on Accrual

First, you can adopt a cap on the amount of vacation time or PTO that employees can accrue. For example, if an employee earns 20 PTO days in a year, you could cap the accrued time at 35 days (1.75 times the employee’s annual accrual rate). If this employee doesn’t use her PTO and accumulates 35 days of unused time, she would not earn any additional PTO until she uses some of her accumulated time. This practice may seem like a disguised “use it or lose it” policy, but California law permits it.

The current state Division of Labor Standards Enforcement Manual provides little guidance on the minimum level of the cap. However, earlier versions of the Manual have stated 1.75 times the annual accrual as a minimum, and it would be risky to adopt a lower cap.

When you first put a cap in place, make sure you give employees sufficient time to use their existing earned vacation before the cap kicks in. In the example above, if you adopted a 35-day cap and the employee had already accumulated 30 days, the employee would have only three months to use vacation before the cap took effect, which would likely be viewed as unreasonable. (Accruing time at five days every three months, the employee would reach the 35-day cap in three months.)

An alternative is to pay down everyone’s accrued vacation to the point where no one has more than one year of accrued vacation on the books. Then all employees would have a full nine months to use vacation before they are capped. (Accruing time at five days every three months, the employee would reach the cap in nine months.)

Another approach would be to lock in the current accrued time off and essentially begin a new vacation plan. Employees would then have 21 months to use vacation earned under the new plan before the cap applied. (In seven three-month periods, the employee would earn 35 days.) An employee who did not have time available under the new plan could use time accumulated under the old plan.

Separating Vacation and Sick Time

You might also consider distinguishing between vacation and sick time. California law does not require employers to pay out accrued sick time. In the example above, shifting to a policy that, going forward, separated five days as sick time (leaving 15 days per year as vacation) would allow you to reduce the cap to 26.25 days. Another benefit of separating vacation from sick leave is that it allows you to permit a much larger accrual of sick leave to give longer-term employees who do not abuse sick leave significant income protection in the event of serious illness, without creating a substantial accrued liability. In transitioning to this approach, be careful not to cause any forfeiture of PTO time accrued up to the date of the transition.

Better Management of Vacation Time

Another strategy is to manage vacation use more effectively. Employers can adopt policies requiring employees to use their vacation time and assuring that they do not accrue excessive vacation; the policies should address the benefit to employees of taking time off. For example, you might require employees to sign up for vacation time for the remainder of the year by a set date and require them to take the vacation as scheduled (or as rescheduled for good reason).

With a minimum of 90 days’ advance notice you can also designate days as vacation days–for example, during the holidays or another slow time of year–and require employees to take those days as vacation. Another option is to allow employees to use vacation time in advance of earning it; this way, employees do not have to wait until they have 10 days earned to take a two-week vacation. You could also endeavor to create a workplace culture that values using vacation time.

ERISA Vacation Plan

One final strategy is to adopt a fully funded, qualified ERISA vacation pay plan. ERISA is a federal law that, when it is applicable, preempts state laws. Therefore, an ERISA vacation plan is not subject to California’s requirements, and you can set up a plan under which employees forfeit accrued vacation when they quit or are terminated. For a vacation plan to qualify under ERISA, it must be fully funded through a trust so it does not pay benefits from the employer’s general assets.

Our HR Management & Compliance Report: How To Comply with California and Federal Leave Laws, covers everything you need to know to stay in compliance with both state and federal law in one of the trickiest areas of compliance for even the most experienced HR professional. Learn the rules for pregnancy and parental leaves, medical exams and certifications, intermittent leaves, required notices, and more.

The trust must be a separate fund that has a direct legal obligation to pay benefits. An employer’s contributions to the trust are actuarially determined and must be sufficient to cover the plan’s obligations to pay vacation. The plan must also comply with other ERISA requirements, including annual reporting. Because funding the trust has an immediate impact on cash flow and because it is difficult to operate an ERISA plan and trust, few employers choose this approach, but it is an option.

Thomas N. Makris, Esq., SPHR, is counsel at the Sacramento office of the law firm Pillsbury Winthrop Shaw Pittman LLP.