ERISA Preemption Of Vacation Policies

Federal law preempts all state laws that relate to "any employee benefit plan" covered by the Employee Retirement Income Security Act. Employers may use the preemptive effect of ERISA to avoid California law on the accrual and vesting of vacation benefits, if they observe the rules for making vacation pay part of an ERISA benefit plan.

Under California law, vacation benefits are considered part of an employee's wages. Vacation pay accrues and vests day by day over the course of the employee's employment. Once the employee has earned the vacation pay, it cannot be forfeited. Use it or lose it policies are illegal. For a full explanation of the California rules on vacation pay, see Section 15 of the Labor Commissioner's Enforcement Policies and Interpretations Manual.

In  Massachusetts v. Morash, 490 U.S. 107 (1989), the Supreme Court held that ERISA did not preempt Massachusetts law that required employers to pay employees all accrued vacation and holiday pay upon termination of employment. Congress did not intent "to subject to ERISA's reporting and disclosure requirements those vacation benefits which by their nature are payable on a regular basis from the general assets of the employer and are accumulated over time only at the election of the employee." However, vacation pay plans that have assets independent of the employer's general assets might constitute ERISA benefit plans.

A plan that merely establishes a trust fund that reimburses the employer for vacation payments is not sufficient to bring the plan under ERISA, even if it qualifies as a tax-exempt Voluntary Employee Beneficiary Association (VEBA) trust under the Internal Revenue Code. See Millan v. Restaurant Enterprises Group, Inc., 14 Cal. App. 4th 477 (1993). By contrast, the Morash decision recognized that a trust created under multi-employer plan that was the actual source of vacation benefit payments probably would fall under ERISA. For a full explanation of the U.S. Department of Labor's interpretation of the relevant principles, see Advisory Opinion No. 2004-10A.

Vacation Pay

California employment law requires special treatment of vacation pay. Although employers are not required to offer vacation pay at all, if they do, they must adhere to certain rules.

By operation of California Labor Code section 227.3, vacation pay is treated as part of an employee's wages, which vests as it is earned. Because it vests, it can never be forfeited. Use it or lose it policies are prohibited.

Because these rules only apply to vacation pay, it is important to understand what that is. The California Labor Commissioner considers any leave time that is offered without condition. Personal time off and personal and floating holidays are examples of benefits that are considered to be vacation. Thus, an employer who provides 10 days of paid vacation plus a paid personal day has actually provided 11 days of what the Labor Commissioner considers vacation. The benefit accrues at a regular rate throughout the year.

Paid leave that is tied to an objective standard is not vacation. Holiday pay is not vacation, because it is tied to the occurrence of the holidays recognized by the employer. Bereavement leave is not vacation, because it is tied to the death of a family member. Sick leave is not vacation, because it is tied to the employee becoming ill. Note, however, that an employer that lumps sick leave and vacation together as paid time off must treat all that leave time as vacation.

Although an employer may not impose it a use it or lose it policy, it may impose accrual caps. An accrual cap is a limit on the amount of paid leave that an employee may accumulate. After the limit is reached, no further paid leave accrues until some is used. But, the employer must set the accrual cap high enough so that the employee has a realistic chance of taking the entire vacation and still continuing to accrue vacation. A cap of two times the annual allotment is considered fair. Thus, if the employer offers two weeks of vacation, it should set the accrual cap at four weeks.

Employers may also control when vacation starts to accrue and when it may first be used. Thus, it is permissible to require employees to work six months before they begin to earn vacation, or to prohibit the use of earned vacation within the first six months of employment. The employer may not accelerate accrual. For example, a policy that postponed the accrual of vacation for six months could not then vest each employee who passed the six month mark with a week of paid leave.

There are two limited exceptions to California's vacation pay rules:

1. Employees covered by a collective bargaining agreement are limited to the vacation pay provisions in the collective bargaining agreement.
2. The requirements of section 227.3 are preempted by federal law if the employer offers paid leave as part of a legitimate ERISA plan. For further explanation of this exception see Czechowski v. Tandy Corp., 731 F. Supp. 406 (N.D. Cal. 1990) and Section 15 (Vacation Wages) of the DLSE Policy and Interpretations Manual.