Paid Time Off Explained: What Business Owners Need To Know

Paid time off (PTO) is a policy allowing employees to take time off from work for any reason and receive their regular pay. Instead of having separate vacation, personal and sick days in a traditional paid time off system, PTO combines leave into one bank system. This all-inclusive plan provides more flexibility for employees.

Offering paid time off in a traditional or bank system is essential for employers to stay competitive. It helps attract and retain talent, prevent burnout and manage employee wellness. New employee burnout research reveals that 66% of employees experience burnout, with younger generations experiencing burnout rates over 80%. When employees take time off to relax and travel, they can better manage workplace stress.

How Does PTO Work?

Paid time off policies vary significantly in many areas, from how many days are offered to when leave expires. Your company policy should have paid time off explained in detail in your employee handbook. There are three primary systems for how employees receive leave.

• Front-Loading Annual Allotment: In a front-loading system, employees receive all days in a lump sum on a specific date, either at the start of the year or annually on their hire date. The days may also expire on this same date each year. The number of days received can be based on years of service, or everyone can receive the same amount regardless of years worked. This system can be costly for employers to pay out if employees leave the company early in the year.
• Accrual System: Instead of a lump sum allotment, leave is earned in increments based on time worked. Employers set their accrual rate, which determines how much leave an employee will earn in a specific period. It can be based on hours worked, regular intervals, tenure or tiered. ADP has a detailed list of questions to answer when creating a PTO accrual policy.
• Unlimited PTO: When employees have unlimited PTO, there are no caps on how much leave they can use if they meet their work responsibilities, but it often needs manager approval. Instead of allotting or accruing leave, they can take as much time off as they want. This system can be difficult to manage fairly. Employees with unlimited PTO may take less time off than those without unlimited PTO, as employees fear using it and may not be motivated to use it before it expires. There are no payouts when employees leave the company.

If you are thinking about switching your current leave system to unlimited PTO, keep in mind that some states may require you to pay out unused accrued leave before making the change.

The U.S. Chamber of Commerce recommends offering 10 days of PTO as a starting point, not including sick days and holidays. Companies can determine how many days to offer, whether or not the leave will expire, how much can rollover, and how employees will be incentivized to use PTO.

Some employers may require employees to take some days off before accruing more leave when certain limits are hit. Employees may be able to donate leave to a centralized bank, directly to a coworker, or as a payout to a charitable organization. Companies can set blackout dates for days when employees cannot use leave. Employees are not required to disclose why they are taking personal days.

Types of Paid Leave

There are many categories of paid leave, including vacation leave, sick leave, personal leave, floating holidays, paid holidays, bereavement leave, family and medical leave, and jury duty. Employers may choose to have separate categories for each or group all categories together as one kind of leave called PTO. Some companies may include holidays and floating holidays in PTO, while others offer separate holiday pay in addition to PTO.

PTO Versus Vacation Time

Paid time off (PTO) has many benefits with the all-inclusive system that combines many types of leave into one category. For companies that have distinct categories of leave, vacation time is the category employees use to take vacations or personal days. PTO and vacation time policies vary in structure, management, benefits and drawbacks.

Research shows that less than half of workers use their full allotment of paid time off. Furthermore, when they do take vacations, many still check work emails. Not being able to full unplug from work contributes to employee burnout.

PTO Benefits

Choosing a PTO policy has benefits for employees and employers. With simplicity and flexibility, it streamlines time-off management while supporting work-life balance.

• Simple: Having only one category for leave makes it simple for employers to administer and for employees to use.
• Flexible: Employees benefit from the ease of taking leave for any reason without having to classify it or provide justification. This flexibility can enhance company culture with trust and autonomy.
• Protects privacy: Employees do not have to share any details about why they are taking leave, providing valuable privacy protection.
• Less administration: PTO requires fewer resources to administer and manage compared to traditional leave systems.
• Enhances wellness: Employees can stay home when sick or freely take off for appointments without having to worry about saving leave for other things. PTO, especially when unlimited, can reduce employee stress and burnout when employees feel encouraged to use PTO.
• Diversity: Employees can easily take time off for religious and cultural observances that are not part of the regular holiday schedule.

PTO Drawbacks

Without distinct categories, the drawbacks of PTO include compliance and administration challenges. While the goal is to encourage employees to use their leave, they may be reluctant to use PTO.

• Employees may use too little or too much: Employees may come to work sick since they want to save their PTO for vacations and personal use. In unlimited PTO plans, employees may take too much time off, or they may take too little if they fear using it.
• Confusion: Policies may lack the clarity that employees need to prevent confusion and frustration when using leave.
• Compliance challenges: It is harder to comply with state and local laws for specific types of leave, such as sick leave, when all leave is lumped together in one category.
• Harder to track: It is more difficult to track, especially when manual methods are used instead of automated tracking.
• Difficult to administer fairly: Since managers need to approve leave requests, they may inconsistently administer the policies, causing challenges with fair usage and administration.

Vacation Time Benefits

Having a separate category for paid vacation time has several benefits. From enhanced compliance to employee willingness to use leave, vacation time can be desirable.

• Categories provide clarity: Employers can gain valuable insight simply by observing which categories of leave their employees use most frequently. The distinct categories are easier for employees to use without confusion.
• Employees may be more willing to use it: When leave is divided into clear categories, employees may be more willing to take a sick day knowing that it does not affect their vacation time. It can also be easier for employees to manage their paid time off.
• Compliance with state laws: Dividing leave into categories makes it easier to ensure compliance with state laws that regulate sick leave, bereavement, family leave and jury duty.
• Encourages work-life balance: Having leave specifically dedicated to vacations helps encourage employees to take time off to rest, relax and recharge.

Vacation Time Drawbacks

Vacation time has drawbacks compared to PTO, including scheduling issues and less flexibility. Depending on the specific situation, it may contribute to employee burnout.

• Limited flexibility: Employees have less flexibility with the reasons they can use vacation leave, unlike PTO, which allows leave to be used for any reason.
• Not enough days: Policies may be too short for the length employees desire for vacations.
• Harder to schedule: From blackout days to providing staff coverage, it requires advanced planning and more administrative resources.
• Employee burnout: If not effectively managed, employees can feel overwhelmed when they return to work or may feel they cannot fully disconnect when on vacation. If leave rolls over into future years, employees may not take the vacations they need to prevent burnout.
• Extended absences: When employees take all their vacation time at once, finding adequate coverage for extended absences can be challenging and result in more work for the employee upon return.

PTO Laws

While some states and local jurisdictions have laws regulating paid time off, most employers are not required by federal law to offer paid leave.

“There are, however, two exceptions: Employers engaged in government contract work and federally-supported contract work falling under the McNamara O’Hara Service Contract Act (SCA) or Davis-Bacon and Related Acts (DBRA). These two acts use the prevailing local standard for fringe benefits to determine if PTO needs to be offered. If the prevailing local standard is to offer PTO, then PTO must be offered.” – Bernie Portal

Any paid leave offered must comply with the standards set and enforced by the Equal Employment Opportunity Commission (EEOC) to ensure it is accessible and administered fairly without discrimination against protected classes.

According to the Americans with Disabilities Act (ADA), “If an employer receives a request for leave for reasons related to a disability and the leave falls within the employer’s existing leave policy, it should treat the employee requesting the leave the same as an employee who requests leave for reasons unrelated to a disability.” Furthermore, allowing unpaid leave should be viewed as a reasonable accommodation for employees with disabilities when paid leave has been exhausted or is not offered.

State laws may impact what type of leave you are permitted to offer, what stipulations are attached to it, rollover requirements, and how much unused PTO to pay out when an employee leaves the company. Since state PTO laws vary greatly, it is essential to know the PTO laws in your state. For example, Pennsylvania does not have a statewide PTO law, but three localities do mandate paid sick leave: Philadelphia, Pittsburgh and Allegheny County.

Employers are not required to pay out remaining leave when an employee leaves the company unless an employment contract or state law specifies otherwise. A PTO payout is taxable income. In some states, employers will face penalties if unused paid leave is not paid out to terminated employees. Massachusetts has a severe penalty for unpaid PTO: a fine of $24,000 for the first offense and $50,000 for subsequent violations.

According to the U.S. Department of Labor (DOL), “13 states and the District of Columbia have laws that create paid family and medical leave programs for eligible workers.” Nearly 20 states have paid sick leave laws.

Ensure that your paid time off policy complies with laws and is easy for employees to use. Whether you choose to offer PTO or separate categories of leave, what matters most is how you define your policy and how you communicate it to employees.