Unlocking the Benefits of PTO Payout: A Comprehensive Guide for Your Organization

Quality of life at work is foundational to retaining employees today: Ninety-three percent of workers consider their wellbeing at work to be equally important to their salary, according to The State of Work-Life Wellness 2024 from Wellhub.

So, what exactly does wellbeing look like? 

For many people, one of the biggest perks that lets them take care of their wellness is paid time off (PTO). PTO typically includes vacation days, sick leave, and other forms of time away from work. Some employees may not use all their time off each year, but you can still compensate them for that PTO. 

This is where employee payout comes in, which can be a key aspect of your compensation strategy. By understanding the nuances of PTO payout, business leaders can make informed decisions that benefit both their employees and the organization’s financial health.

What is PTO Payout?

PTO payout is the process of compensating employees for any unused or accrued PTO days. This often happens when an employee leaves an organization or at a designated payout period, such as the end of the year. 

• Accumulated PTO: Many company policies allow employees to accrue PTO over time based on their tenure. This means that employees accumulate a certain number of PTO days for each month or year of employment.
• Unused PTO: Unused PTO days are those that employees have earned but have not yet used for time away from work. Over time, employees may end up with a bank of paid leave they can either use or wait for a payout.

Each organization may have its own PTO payout policies and guidelines. It’s best to communicate these policies to employees during onboarding to help set expectations from day one. It’s also important that you follow both legal requirements and industry standards. Based on the state you operate in, there may be specific requirements that need to be accounted for in your policy. 

Why is PTO Payout Important?

There are benefits for both the employer and the employee when organizations offer PTO payout.

Employee Retention and Satisfaction

Firstly, PTO payout is an attractive incentive offered in some employee benefit packages. Knowing that they can receive money for their unused PTO days motivates employees to stay with the company. This can contribute to higher employee retention rates and boost overall job satisfaction.

Financial Security for Employees

PTO payout also provides financial security to employees throughout their careers. When they leave the company or retire, receiving a payout for their accrued PTO can be a valuable source of income. Having salary transparency about not just their income but their potentially unused PTO helps employees prepare for the future, no matter the circumstances. 

Encourages Responsible PTO Management

Employees who can count on PTO payout tend to use their vacation time and sick days responsibly. Knowing that their unused PTO will not go to waste urges employees to use their time off more intentionally. This creates an environment where individuals can improve their wellbeing while boosting productivity.

Legal Compliance

In many states, labor laws require employers to pay out accrued, unused PTO when employees leave the company. Complying with these legal obligations helps employers avoid potential penalties.

Positive Company Culture

PTO payout can contribute to a positive company culture that values work-life wellness. When employees feel like their time away from work is respected and rewarded, they are more likely to be engaged and motivated in their roles.

Improved Employee Productivity

Everybody needs to step away from work now and then. Regular breaks and time off can help improve employee productivity and reduce burnout. When employees have the opportunity to recharge through the use of their PTO, they often return to work with increased focus and energy.

When to Cash Out PTO

Part of your company’s benefits strategy is deciding how PTO payouts work, which may depend on company policies and state regulations. Here are some general guidelines for when employees can cash out their accrued PTO.

Common PTO Payout Timelines

• Separation from the Company. When an employee leaves due to resignation, retirement, or termination, accrued but unused PTO is typically paid out. The timing of this payout can vary, but it often occurs in the final paycheck or within a specific timeframe mandated by state labor laws.
• End of the Year. Some company policies allow employees to request a PTO payout for any unused days at the end of the calendar year. This option can help employees who want to receive the payout before the new year begins.
• Company Policies. You may create a unique policy for unused PTO that aligns with your company culture. Just remember to communicate these policies with employees and include them in the employee handbook.

Especially if you are designing your own guidelines, it’s important to understand PTO payout laws by state. These laws dictate when and how PTO must be paid out to employees upon separation.

Employee Request Process

It’s also best to include clear instructions for employees who wish to request a PTO payout. Upon reviewing the company procedures. these are often the steps that follow:

1. Submit a Request. Typically, employees submit a formal request for PTO payout to their HR department or manager. This request may be in writing or through an electronic system, depending on the company's procedures.
2. Provide Adequate Notice. In some cases, employees may be required to provide advance notice when requesting a PTO payout, especially if it is not tied to leaving the company. Giving notice allows the employer time to process the request and calculate the payout.
3. Await Approval. Once the request is submitted, employees await approval from their employer or HR department. Employers may evaluate the request based on factors such as the company's policies and available budget.
4. Receive Payout. If the request is approved, employees will usually receive the PTO payout in their regular paycheck or following the company's payout schedule.

Taxation of PTO Payout

Employers are responsible for withholding the appropriate federal and state income taxes as well as FICA taxes from PTO payouts. These withheld taxes are then remitted to the respective authorities on the employee's behalf. 

Employers are also required to report PTO payouts as taxable income to the employee on their W-2 form., W-2s must be provided to the employee and filed with the IRS to comply with tax laws.

In most states, earned PTO is considered a type of wage, meaning it can be documented as taxable income. This means that the amount received as a PTO payout is subject to federal income tax, state income tax when applicable, and Social Security and Medicare taxes.

The specific tax rate applied to the PTO payout will depend on the employee's income, deductions, and tax brackets for the year the payout is received. It falls to the employer to set up an effective payroll system that handles tax deductions for employee PTO.

Strategies to Minimize Taxation

To minimize the tax burden, employers can lean on the following tactics:

• Deferring PTO Payout. Employees can sometimes defer their PTO payout to a future year. This can help spread the tax liability over multiple years, which may lower tax rates if the employee expects a decrease in income.
• Contributing to Retirement Accounts. Some people contribute their PTO payout directly to tax-advantaged retirement accounts, such as a 401(k) or an Individual Retirement Account (IRA). This can help simultaneously reduce their current taxable income and save for retirement.
• Adjusting Withholding. Employees can review and adjust their withholding allowances on their W-4 form to account for the additional income from the PTO payout. This can help ensure that enough taxes are withheld to cover the tax liability associated with the payout.

Calculating PTO Payout

Calculating PTO payouts considers wage rates, accrued PTO, and tax deductions. This helps employers determine the net payout for employees, whether they are hourly or salaried.

Hourly Employees

For hourly employees, you can start by calculating the monetary value of their accrued, unused PTO days. Here’s the breakdown:

1. Determine the employee's hourly wage rate, not including any overtime pay or bonuses.
2. Calculate accrued, unused PTO hours based on the company's policy. 
3. Multiply the hourly wage rate by accrued PTO hours to calculate the PTO payout. The formula looks like this: 
   PTO Payout = Hourly Wage Rate x Accrued PTO Hours
4. Deduct federal and state income tax, as well as FICA taxes, from the payout.
5. The net PTO payout is the remaining amount after tax deductions.

Salary Employees

For salaried employees, this process looks a little different. The basic steps include:

1. Determine the employee's annual salary. This is the employee's fixed yearly pay before any deductions or adjustments.
2. Calculate the daily salary rate by dividing the annual salary by workdays in a year. Here’s the simple formula: 
   Daily Salary Rate = Annual Salary / Number of Workdays in a Year
3. Determine the number of accrued, unused PTO days.
4. Multiply the daily salary rate by accrued PTO days to calculate the PTO payout. You can use this formula:
   PTO Payout = Daily Salary Rate x Accrued PTO Days
5. Deduct federal and state income tax, as well as FICA taxes, from the payout.
6. The net PTO payout is the remaining amount after tax deductions.

PTO Legal Requirements

There is no federal law that requires employers to include PTO or PTO payout in employee benefits. However, it is something to consider if you want to prioritize employee wellness and offer competitive compensation packages. Plus, some states do require PTO payouts — so your legal obligations depend on where your organization operates.

PTO Payout Laws by State

PTO payout regulations vary based on state labor laws, which impacts whether employers are required to pay out unused PTO or if a "use-it-or-lose-it" policy is allowed. These states require PTO payouts in most scenarios:

• California
• Colorado
• Illinois
• Louisiana
• Massachusetts
• Nebraska
• North Dakota
• Rhode Island
• Washington, D.C.

There may be some exceptions — there are places like the District of Columbia where PTO payout is required unless the company policy states otherwise. As a general rule, most states will hold companies responsible for payments if their company policy calls for it. Essentially, an organization must follow its own rules, so double check that your policy considers the law and your company culture during benefit plan administration.

 "Use-It-or-Lose-It" Policies

Some states prohibit "use-it-or-lose-it" policies. This means that employers cannot require employees to forfeit unused PTO at the end of a specific period, such as the end of the year. Instead, employees in these states have the right to carry over their unused PTO to the following year. 

• California
• Colorado
• Montana
• Nebraska

PTO Payout Scenarios

PTO payouts may work a bit differently depending on how the employee leaves your company. 

PTO Payout When Quitting

When an employee quits or is terminated, they may be subject to PTO payouts based on company policies and state laws. While most states don’t require this, the following states typically do: 

• California
• Colorado
• District of Columbia (Washington, D.C.)
• Illinois
• Indiana
• Louisiana
• Maine
• Maryland
• Massachusetts
• Minnesota
• Montana
• Nebraska
• New Mexico
• New York
• North Carolina
• North Dakota
• Ohio
• Rhode Island
• West Virginia
• Wyoming

For other states, payout requirements depend on the company’s PTO policy or employee contract.

Consequences of Not Paying Out PTO

As you consider your PTO payout policy, there are legal repercussions and consequences related to employee wellness depending on your choices.

Legal Consequences

Not paying out accrued PTO as required by labor laws can result in significant legal consequences for employers. For states that mandate PTO payout, these consequences can be severe since earned PTO is considered a form of wages. 

Failure to comply with PTO payout laws may lead to legal actions such as wage and hour claims and fines imposed by labor authorities. In some cases, employers must pay two to three times the amount of unpaid wages. This is not only costly for the company but also damaging to their reputation.

Impact on Employee Morale

Aside from legal issues, employee motivation and wellbeing can be negatively affected, too.  It can erode trust and job satisfaction among the workforce, leaving employees feeling undervalued and disengaged. Employees may be less motivated, too, which takes a toll on productivity and increases turnover rates. 

This can lead to a sense of mistrust around paid time off altogether, leading to greater absenteeism and burnout. On the other hand, employees who are fairly and generously compensated are often more engaged and committed to their work.

Year-Round PTO Payout with PTO Conversion

PTO conversion allows employees to transform their accrued PTO into other forms of compensation or benefits throughout the year. This flexibility offers more choices in how people use their PTO, whether for additional income or retirement savings. This level of trust and autonomy is excellent for work-life wellness and building employee loyalty.

It can be beneficial for the organization, too. PTO conversion is just one extra element that makes your benefits package all the more competitive. This means attracting top performers in your industry and retaining that talent. Ultimately, CEOs looking for increased productivity and a positive workplace culture can offer flexible benefits like PTO conversion.

Work-Life Wellness Can Start with PTO Benefits

Employees need opportunities to balance the things that matter most to them, including their home life and work responsibilities. A policy that includes PTO payouts is a sign that employers value and trust their employees — and it makes your company’s compensation strategy even more attractive. 

Another way to show employees that you value them is to support their wellness. As you work to boost employee satisfaction and retention, you may want to consider the benefits of employee wellness programs. 

Around 75% of U.S. employees say that they consider employee wellbeing programs one of the reasons they stay at their jobs. To take advantage of the perks of a wellness program, talk with a Wellbeing Specialist.