Paid vacation is a powerful tool for recruiting and retaining employees. The opportunity to rest and recharge can improve employee morale and boost productivity. But paid vacation costs real money; and, to get the most for that money, employers should understand the law governing paid vacation.
In most states, including New Jersey, New York and Pennsylvania, accrued vacation is treated as earned income, and, when an employee leaves a job voluntarily or otherwise, the employer must include payment for accrued, but unused vacation in the final paycheck. In addition, because accrued, but unused vacation is treated as earned income, an employer may not condition its payment on an employee’s agreement to post-employment conditions such as non-competes or releases from liability.
For even a small business, accrued but unused vacation can result in a significant balance sheet liability. To avoid that consequence, employers should put in place a “use it or lose it” policy. Paid vacation is not a retirement benefit. Its purpose is to enable employees to take time off to recharge and to return to work with renewed energy and enthusiasm. To ensure that employees use vacation for the purpose for which it is intended, employers should require that employees use their vacation days in the period in which they are accrued. That can be a calendar year, an employment year, or a rolling 12-month period. Unused days are zeroed out at the end of the accrual period, thereby limiting the size of a potential balance sheet liability.
To maximize the incentive inherent in a paid vacation benefit, vacation accruals should be structured so that they cannot be used until an employee has been employed for a minimum period; for example, six months. In addition, vacation days should accrue gradually over the accrual period. For example, if an new employee is entitled to one week of paid vacation, he or she would accrue .41 day of paid vacation each month, beginning as of the first day of employment, but not be able to use the accrued days until he or she completes six months of employment.
Contact Praxis for more information about how to implement an effective vacation policy.