Unused Vacation Pay and 401(k)

Hi--I just read an article from the Baltimore Sun about a supposed emerging trend I'd never heard about.

Some employers are now allowing employees to put the cash equivalent of unused vacation time into their 401(k)s. Some employers allow employees to put pay from unused vacation at the end of each year into 401(k)s. Others employers with "use it or lose it" policies take the otherwise "lost" pay for these days into the employee's 401(k). It's apparently being used as a recruitment tool, particularly in the health care industry.

Is anyone else familiar with this practice?


  • 7 Comments sorted by Votes Date Added
  • I have heard of this trend too and think it would create a lot of goodwill among employees. It's also good in a time when companies have moved away from pensions and people are worried about their future financial security.
  • This is very interesting.  Because I am not a comp & bens
    expert, I would like to learn how you can manage this if the employee
    is already at their contribution maximum and how it works with the
    discrimination testing and the IRS etc. 


    Thanks in advance for any additional information! 

  • http://library.findlaw.com/1997/Jan/1/126551.html  Found this article where the IRS viewed a contribution like this as not falling under a CODA (since the ee couldn't get the cash instead).  They classified it as a nonelective contribution.

    "As noted above, the linchpin reason why the IRS concluded that contributions of vacation pay to the 401(k) plan were not elective deferrals made under a CODA was that the vacation pay would have been forfeited otherwise. For another company even to consider this strategy, then, its vacation policy must provide for the forfeiture of pay for unused vacation.

    If the company's policy permits employees to defer unused vacation they have accrued, or to receive compensatory pay or other benefits for the accrued vacation, then the analysis of the TAM is completely inapplicable. In that type of arrangement, the contribution of accrued vacation pay to the 401(k) plan would involve a choice between the deferral and cash or another taxable benefit (i.e., the future vacation or compensatory pay). Therefore, the contribution would be made under a CODA and would be subject to FICA tax and the section 402(g) dollar limit on elective deferrals."

    As to nondiscrimination testing, here is what it states:

    "The TAM noted that the vacation pay contribution constituted a "nonelective employer contribution." Under Code section 401(a)(4), contributions provided under a qualified plan must not discriminate in favor of highly compensated employees ("HCEs"). Treasury Regulation section 1.401(a)(4)-2 describes the tests for demonstrating nondiscrimination in the amount of contributions under a defined contribution plan. There are safe-harbor provisions in this regulation that obviate the running of tests, but none of the safe harbors would apply to the payment of forfeited vacation into a plan. The safe harbors not only require a uniform formula that allocates the same percentage of compensation, dollars or dollar amount per unit of service or age-and-service unit for each employee; they also require that nearly all plan participants actually receive the allocation. .."

  • I don't know this, but I would think that this could only be done in states that allow a "use it or lose it" policy.  If you are in a state that considers vacation "earned wages", I would think you could not do this.  At any rate, I would not want to be the one to test this theory.

  • Thanks for that info HRforMe.

    I didn't mention that an expert that was interviewed for the article mentioned that in order to avoid favoring highly paid workers, an employer could set limits on the number of days it contributes for them, or could restrict highly compensated employees from participating.

    Anyway, one of the places that re-ran the article online can be found here if anyone wants to read: http://www.mercurynews.com/business/ci_7304893

  • I agree with LadyAnn that state law would come into play if it was a state that doesn't allow for forfeiture of vacation.  That would change the contribution into a CODA and would have to be tested under the regular nondiscrimination laws as a regular deferral of pay.

  • [quote user="LadyAnn"]

    I don't know this, but I would think that this could only be done in states that allow a "use it or lose it" policy.  If you are in a state that considers vacation "earned wages", I would think you could not do this.  At any rate, I would not want to be the one to test this theory.


    I agree.

    Here  are some other points to consider: the main two points behind a use it or lose it policy are 1) to prevent accumulation of vacation leading to very large disbursements that are difficult to schemdule/budget and 2) to force employees to actually take some time off and get some rest.  If your reason was (1), maybe it's time to reconsider your use it or lose it policy since you are paying it out now anyway.  If your reason was (2), you are now paying people not to take the very vacation you were trying to get them to take.

    I think it would be a good idea to think about policy alignment: what do you want all this stuff to do for the company?  If you want them to work more and take time off less, why not structure an attendance bonus that works essentially the same way and can be used in any state?  If you just want to throw some money out there to make recruitment and retention more successful, why not just have a 401(k) annual bonus plan based on anything?  It seems to me that this idea doesn't make much sense unless a company is reversing the purpose of its use it or lose it vacation policy from being a tool to encourage rest into a tool to encourage attendance.

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