Is “use it or lose it” policy regarding employee vacation time legal?

Under a “use it or lose it” policy, an individual who does not use all of his or her accrued vacation pay by a particular time forfeits the right to be paid fro those days at a later date. The California Supreme Court held, however, that vacation pay vests as it is earned, and any vacation earned cannot be taken away. Vacation pay is, in effect, additional wages for services performed, the receipt of which is postponed. Thus, this “use it or lose it” policy is generally unlawful. Thus, upon termination, for instance, the employer must compensate the terminating employee for unused vested vacation time.

Vacation time is in many ways treated like wages under California law and is actually considered wages for the purposes of compensation. Thus, when vacation is earned during a period of employment (for example, two weeks of paid vacation annually) and the employee does not complete the period, California Labor Code section 227.3 requires compensation for a pro rata share of the unused vacation based on the percentage of the period completed.

Further, an employer may not force an employee to use accrued vacation time rather than serve out the term of his employment. Vacation pay that is not used continues to accumulate unless the vacation policy contains a “cap” on accruals. A “cap” precludes the employee from accruing additional vacation time after a specified amount has been accumulated.

Under California Labor Code section 227.3, unless otherwise provided by a collective bargaining agreement, an employee who is terminated without having taken all accrued vacation time must be paid for the vacation time as wages to his final rate of pay.

However, it is important to distinguish between the “use it or lose it” policy and the “no additional accrual” policy with regard to vacation time, because while the former is illegal the latter is permissible. That is, if the employment agreement precludes an employee from accruing more vacation time after accumulating a specified amount of unused vacation time, this is a lawful policy. Boothby v. Atlas Mechanical, Inc. (1992) This policy makes sense, as for some employers, especially small businesses, a “no additional accrual” policy may be necessary to meet reasonable needs. When an employee takes a short vacation, the company may be able to cover the absence using existing staff and resources with minimal disruption. However, if an employee could accumulated many months of vacation and then take it all at once, the business might not have the resources to absorb the substantial disruption.