Elizabeth Perlak
Apr 10, 2014

Five Things to Consider When Creating a Paid Time Off (PTO) Policy

Creating a vacation policy for your company seems like a relatively simple task, yet it can quickly become confusing and complicated. With no federal laws in the US requiring employers to provide paid leave, options are nearly unlimited on how to structure and account for leave 1. The three factors you should always consider when structuring leave are: company culture, your employees, and your location.

There are two basic types of paid leave. Category 1 leave is only taken occasionally and most employees will use it just once or twice during their tenure at your company (e.g., Parental Leave).

Category 2 leave is granted on an annual basis with the expectation that most employees will use all of the time provided during the course of a year (e.g., vacation).


PTO Policy

Here are five things to consider while creating policies for Category 2 leave types.

One PTO Bank vs. Multiple PTO Day Types

One PTO Bank

A rising trend in designing policies has been to offer one Paid Time Off (PTO) Policy rather than a collection of specific leave (vacation, sick, floating holidays, or personal days) policies. Some of the benefits are listed below.

  • No need to determine why the leave is necessary. If an employee needs time off for a trip to Tahiti, a doctor’s appointment, religious holidays, or to wait for the cable guy, all are covered by the same policy and are drawn from the same bank of days.
  • Create a greater feeling of fairness. This can be effective if every employee receives the same number of days to use.
  • Reduce the number of “sick” call-ins. When you have a separate sick day policy, healthy employees may feel that those sick days are owed to them and create a situation to use them.

Multiple Day Types

For some employers, maintaining specific leave policies may be the right choice.Below are two benefits of using this method:

  • Accrued paid leave might be classified as wages. Some states classify accrued paid leave as wages and require that it be paid out to departing employees. Depending on the state, some leave might be considered wages, while other leave types may be exempt from this classification. For example, it might be permissible to clarify that any unused sick days or floating holidays do not roll over and will not be paid out, but the same treatment of a vacation policy would be a violation of the state law.
  • Clearly demonstrates municipality legislation compliance. Several municipalities have passed legislation that requires certain employers to provide paid sick leave.  Keeping sick leave separate from your vacation policy will clearly show compliance.

Anniversary Date vs. Calendar Year

In addition to day types, you will also need to establish the time period for the policy. The paid time off period can be based on either the calendar year or the employee’s hire date (anniversary year).


By choosing the anniversary year, you don’t have to pro-rate for employees in their first year. Additionally if you choose to tier your policy based on tenure, it is easier for employees to understand where they fall. While management can be more difficult with employees having unique dates and anniversaries, implementing a paid time off tracking system can alleviate that administrative burden.


The other option is to base your policy on a calendar year. Although everyone will be on the same schedule, calculating the amount of leave for an employee who starts mid-year can be tricky. Also, if you have a policy in which employees are required to “use it or lose it” (more on this later), you could find yourself with employees scrambling at the end of the year to use their allotment. If this is a particularly busy time for your company, it may not be the best approach.

Granted vs. Accrued

You also have the option to structure the policy so that the whole bank of days can be granted on day one of the year or create a system where the days are accrued (generally either by pay-cycle or monthly throughout the year).


A grant to employees is mathematically simpler, but if the employee works in a state that requires payout of earned days upon termination, you would be required to pay the value of the entire year no matter when the employee departs your company.


If your policy allows for the accrual of days, one challenge may be that the employee will need to borrow days from the future to take a vacation early in the year. The issue with this approach occurs when an employee departs with a negative balance of vacation days, as you may not be able to collect the value of those days from the employee. Some states prohibit deductions from final paychecks for this purpose.

Tiered vs. Flat

Many companies decide to create different allotments for different groups of employees. One of the most common ways is creating tiers of leave allotment based on tenure with the company. This is one way you can leverage your policies to encourage employee retention.  Another common grouping is based on job title, with more senior or influential positions receiving more paid leave.

Depending on the size of the company, it may not make sense. These policies should be revisited and adjusted as your company changes in size and culture. The issue with tiered policies  is that  the more complicated your policy is, the more administratively burdensome it could become. A paid time off tracking system can help you with this.

Unused Days: Carryover, Caps, and Payout


In most states (California and Montana being the most notable exceptions), carrying over PTO to the following year is at the employer’s discretion. One common solution, (outside of the two mentioned states, is to allow days to carry over, but to place a limit on the number of days. This keeps things from getting out of control and also encourages employees to take the vacation they need. An example would be to limit the carryover to 3 days and require that it be used in the first three months after it is carried over.


California does not recognize “use it or lose it” policies which means that employers must allow employees to carry over unused days from year to year. However, California does allow employers to cap the amount of vacation that an employee can accrue at any given time. California recommends that the cap be 1 ½ times the total annual allotment. (If you provide 10 days of vacation a year, your cap would be 15 days.) This could also be a useful way to structure your PTO in other states.


Depending on state law, you will want to consider paying out accrued (or granted) leave when an employee departs your company. Make sure that what your policy states is compliant with all jurisdictions in which your employees work (including if they work remotely from home). Some states require payout while others leave it to the employer’s discretion.

How does your company handle Paid Time Off policies and what would you recommend?


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1 However, some local jurisdictions, such as San Francisco, Philadelphia and the State of Connecticut, have enacted laws which require some employers to provide paid sick leave. You should always consult state and local law when creating a policy.

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