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Posted: October 03, 2009

Use it or lose it?

The IRS has given workers another choice

Wayne Farlow

Does your company have a "use it or lose it" policy with respect to your vacation or sick leave? If so, the IRS has recently issued new guidelines that can help you save more for retirement when you are unable to use all of your allotted annual leave.

In September, the IRS released Revenue Rulings 2009-31 and 2009-32 to clarify steps that employers can take which would allow employees to contribute unused vacation and sick leave to 401(k) and other qualified retirement accounts. These IRS rulings describe how employers can permit employees to convert the value of their unused leave into contributions to tax-qualified retirement plans.

From an employee morale viewpoint, a "use it or lose it" policy may not be in a company's best interests. While the intention behind the policy is to insure that employees take their allotted time off, it is often difficult to do this every year. This is especially true of valuable, longer term employees who have accumulated several weeks of annual paid leave.

The repercussions of a "use it or lose it" policy is that valuable employees are often "forced" to take time off near the end of the calendar year, a time when most companies need every available employee to meet their year-end goals. The new IRS rulings allow companies to offer an alternative that benefits both the employee and employer.

The new IRS rulings apply to qualified retirement plans, including 401(k)s, Keoghs, profit-sharing plans and SIMPLE IRAs. The rules can apply to unused vacation, sick leave or personal days that accrue either annually or when an employee leaves a job.

The rulings allow the employee to contribute the entire amount of their unused leave to the company's retirement plan, unless the employee has already exceeded the annual plan contribution limit. For 401(k) plans, the 2009 contribution limit is $16,500, or $22,000 for those over age 50. For a SIMPLE IRA, the 2009 contribution limit is $11,500 or $14,000 for those over age 50.

Companies can opt to pay workers for unused leave only if is deposited into their qualified retirement plan. This provides a positive alternative to the "use it or lose it" approach. Instead of being forced to take time off in the critical end of year time frame, employees have the option of saving their unused leave in their retirement plan.

Employers that don't currently pay workers for unused leave may want to consider this approach. Putting unused leave into an employee's retirement account compensates valuable workers and encourages retirement savings with no increase in base pay.

Another benefit of adding this alternative is that neither the employer nor the employee will pay FICA taxes on the contribution, since the payment is to a qualified retirement plan. An employer who offers this benefit must offer it to all plan participants. However, the employer is not required to offer it every year. The employer can also prorate or limit the amount of leave for which they will pay.

If you own a company that has a 401(k) or SIMPLE IRA retirement plan, you may want to consider modifying your plan to allow for unused paid leave to be put into the qualified retirement plan. As a business owner in trying economic times, you are likely very concerned about keeping company morale high.

You are also aware of the correlation between high employee morale and high employee productivity. Providing a method for your employees to retain their earned leave time plus save for retirement could be a major morale booster for your company.

If you are an employee of a company that has both a qualified retirement plan and a "use it or lose it" vacation policy, talk to your company management or personnel department about these recent IRS rulings. They may not be aware of how the new IRS rulings can provide a new alternative to "us it or lose it."

Our nation must begin to save more for our long term health and security. Hopefully, many companies will take advantage of this opportunity to help employees save more for retirement.

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Wayne Farlow is the founder of Financial Abundance, LLC, a Registered Investment Advisor firm.  He is a Certified Financial Planner (CFP®), focusing on Retirement Planning, Investment Management, Small Business Owner Planning and Sudden Wealth/Inheritance Planning.  His book, “Financial Abundance Guide,” is available free at www.farlowfinancial.com .  He can be reached at wayne@farlowfinancial.com or at 303-554-0309.

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