QUESTION: We are thinking about amending our cafeteria plan to allow employees to buy additional paid time off (PTO). How does PTO buying work under a cafeteria plan?
ANSWER: A PTO buying feature under a cafeteria plan allows employees to prospectively elect, during the annual open enrollment period before the beginning of each plan year, to buy additional PTO (i.e., more PTO than they would otherwise receive from the employer) with salary reductions or flex credits, for use during the upcoming plan year. The rules for PTO buying under a cafeteria plan are complex, but here are a few important legal points to keep in mind:
No Deferred Compensation. The PTO buying feature must not operate to defer compensation from one plan year to the next. This means that PTO bought under the cafeteria plan (the IRS calls this “elective” PTO) for use during a particular plan year generally must be used, cashed out, or forfeited by the end of that plan year and cannot be carried over for use in a later plan year.
Ordering Rule. A special ordering rule requires nonelective PTO (i.e., regular PTO accruals outside of the cafeteria plan) to be used before elective PTO. Thus, elective PTO can be used only after employees have exhausted all of their nonelective PTO. The practical consequence of this rule is that employees must use all of their PTO (whether elective or nonelective) to avoid a cash-out or forfeiture of any elective PTO at the end of the plan year. Thus, a PTO buying feature under a cafeteria plan may not fit well with a PTO arrangement plan that allows unused nonelective PTO to carry over to future years. A buying feature might also conflict with state laws that prohibit forfeiture of unused PTO.
These are just a few of the legal issues to consider before amending your cafeteria plan to include a PTO buying feature. Because this type of design is complex, we recommend that you seek the advice of experienced benefits counsel before implementing PTO buying under your cafeteria plan.
For more information, see EBIA’s Cafeteria Plans manual at Section X.E.2 (“Purchase or Sale of Paid Time Off”); see also EBIA’s Fringe Benefits manual at Sections XXII.F (“Buying or Selling Vacation/PTO Days Under a Cafeteria Plan”) and XXII.G (“Other Laws Affecting Vacation/PTO Plan Design”).
Contributing Editors: EBIA Staff.