The Benefits of Paid Time Off

Alex Korotin


May 1, 2011

"I don't set trends," entertainment legend Dick Clark once proclaimed. "I just find out what they are and exploit them."

Businesses across all sectors can benefit from his approach as they explore cost-saving practices adopted by other organizations in response to an economic downturn or a company's cost-saving initiative. One human resources benefit strategy sparking interest and gaining momentum across the business world is "paid time off" (PTO) in place of traditional time-off programs.

Traditional plans divide time into "vacation," "sick" and "personal" days. Vacation days must be scheduled in advance, sick days sometimes require a doctor's note and personal days act as emergency time for family and personal matters. The PTO approach, by contrast, combines time-off allowances into one pool of PTO days. The administration is simplified; instead of filing each employee absence under a separate category, administrators create a single system for keeping track of total time off.

Employees are encouraged to plan ahead for vacation, but do not require substantiation for impromptu time off, which is more convenient for the employee and results in fewer unplanned absences. Because PTO days are not differentiated, employees who take fewer sick days have more time for vacation, thus encouraging healthy behavior.

Many traditional time-off plans allow for unlimited rollover of sick time, resulting in long-term employees accumulating hundreds of sick days and leaving the employer with a large unfunded liability on their books. A use-it-or-lose-it PTO arrangement, whereby any unused PTO days are forfeited at the end of the year or a PTO program with an annual rollover cap, can help employers avoid this scenario.

One drawback, however, is that this reasoning can lead to employee "presenteeism" -- sick employees may come to work to preserve their PTO days. But this risk can be managed by establishing an organizational culture that encourages sick employees to stay home. In the right environment, where workers are treated with respect, given flexibility and expected to use it responsibly, the desire to "pull one over" on the company will wane and employees will keep their viruses out of the office out of courtesy for their co-workers.

The PTO arrangement may be introduced alone, in conjunction with a credit-based flex plan, or harmonized with 401(k) or profit sharing plans. Credit-based flex plans involve an employer providing each employee with "flex credits" that can be used to pay for their employee benefits (e.g., employee life, disability and health coverage) or converted to taxable compensation. When offered a PTO arrangement alongside a credit-based flex plan, employees can trade unused or otherwise forfeited PTO days for flex credits.

Employers who are interested in exploring the benefits of a PTO framework but do not wish to implement a credit-based flex plan can create additional value for their employees by leveraging recent IRS Revenue Rulings (2009-31 and 2009-32). These rulings permit employees to convert unused PTO into contributions to their 401(k) or profit-sharing plans.

This approach can help employers create additional benefits value without increasing their costs. Employers may, however, incur additional expenses associated with anti-discrimination testing if highly compensated individuals are allowed to participate in the plan. The 401(k) contributions, when converted from unused or forfeited PTO days, qualify as an employer non-elective contribution, thus allowing employees to contribute up to their annual maximum plus any catch-up contribution if they are over a specified age.
Alex Korotin is an actuarial analyst with Spring Consulting Group, LLC.