Can employees purchase annual leave?

One of many strategies gaining popularity as the issue of work/life balance gains momentum is referred to as 'purchased leave'. A purchased leave scheme creates an option for both employers and employees for salary negotiations, and can help both parties to secure a better deal for themselves, depending on their own priorities and needs.

What is purchased leave?

Basically, a purchased leave policy allows employees to increase their annual leave entitlements in exchange for sacrificing the equivalent salary value. 

How does it work?

Employees may increase their amount of annual leave entitlement, typically by an extra two or four weeks per year, in exchange for giving up the equivalent amount of salary.

For example, if an employee takes four weeks’ annual leave and four weeks’ purchased leave, they are paid for the equivalent of 48 weeks of the year, but payment is spread out evenly over the full 52 weeks.

It is not a case, however, of an employee deciding at short notice that they would like to take four weeks’ extra annual leave because something has come up.

Most employers with a purchased leave policy require employees to submit their applications to cover a calendar year at the beginning of that year. This is not essential for all businesses to do, but it does make it easier to plan and schedule work around the absences, and to calculate and spread out the reduced rate of remuneration.

Who uses purchased leave?

The most frequent users of purchased leave tend to be parents who need to care for children during school holidays, as the latter periods amount to much longer than four weeks per year.

School holiday periods are known well in advance, so it is easy for parents to comply with the 'start of year' application deadline noted above.

For businesses that employ a lot of parents, you may need to determine if your business can cope with school holiday periods if most of them want to take leave at the same time. You may have to look at a rostering arrangement. For example, some employees can take Term 1 holidays, others take Term 2, etc.

You must also consider the impact on other employees. Purchased leave is common for school holiday arrangements, but it could also be used to cover study, travel, voluntary work, taking part in election campaigns, or various other events. Or an employee who is financially secure may simply prefer to sacrifice some income in order to take more holidays each year.

What are the legal requirements surrounding purchased leave?

Legislation and awards set minimum standards for annual leave, generally four weeks per year, but sometimes more for certain industries or certain types of work. Employers can provide more generous entitlements to employees in the employment contract if they wish, so there is no legal impediment to offering purchased leave arrangements.

One issue that may require care, however, is an employee’s remuneration level. As purchased leave reduces this level, you need to check that remuneration does not fall below any statutory minimum rate as set by an award or agreement.

Note that if the basic remuneration level falls, so will the value of other entitlements based on it. The main ones are superannuation contributions, leave loadings, shift loadings and overtime payments. It is important to point this out to employees, and set out in detail how their remuneration will be affected by taking up a purchased leave option. It is prudent to advise employees to consider carefully all the financial implications of purchased leave and seek independent financial advice before applying for it.

The potential impact on your business

You also need to assess the impact on the business. Based on four weeks’ purchased leave per year, a simplistic calculation is that an employee’s work output might drop by 8% per year but their remuneration cost also drops by 8%.

Study workflow arrangements and work volumes to assess whether the business will be able to carry the absences.

For example, where maintaining customer service levels is a high priority, you might have to look at employing casual/temporary staff at certain times to cover employees on leave. Where employees have a high degree of control over planning their work, this may not be an issue because they can plan around their absences.

Finally, there are the extra preparation, promotion, administration and evaluation costs that affect all new HR policies.

The above costs may be offset by the potential value of purchased leave as a retention tool. Employees may go elsewhere if other employers offer more flexible work arrangements. Also, although it’s hard to quantify, anecdotal evidence suggests that employees that receive work arrangements that suit them tend to value the benefit highly and are committed to making sure it works effectively.

In practice, remuneration might drop by 8% but work output may fall by less than that and may even remain the same.

Determining a purchased leave policy

Assuming the cost/benefit analysis and employee survey are favourable, the next step is to decide on a policy. This should address whether purchased leave should be available to all employees or restricted to certain circumstances.

One approach is to state that no-one has an automatic entitlement to purchased leave, but anyone can apply for it and approval will be at the line manager’s discretion – perhaps backed by an appeal process involving the HR manager or another senior manager.

Each application will be assessed in light of the workload and other requirements of the business or work unit at the time applied for. You could also state that the employee’s reason for seeking leave will be taken into account, which may be helpful if you receive more applications than the business can cope with, and have to prioritise them.

If you handle this process fairly, you should be able to maintain control over the situation.

Another possibility is to set a minimum qualifying period for eligibility for purchased leave. No employee has a statutory entitlement to annual leave until they have completed one year’s service (except if the parties agree for the employee to take leave in advance), but you could consider a qualifying period of three or five years.

How much purchased leave is appropriate?

The most common arrangements are for two or four extra weeks’ leave per year. Usually they specify minimum 'blocks' of leave, such as 2 x 1 week or 2 x 2 weeks, or take the whole entitlement at once.

Calculations of remuneration can become very messy if you allow purchase of shorter periods of leave than this. They will also be messy if you don’t set specific amounts of purchased leave, such as two or four weeks.

Purchased leave and administration

Most organisations require employees to indicate their purchased leave intentions in advance, such as at the beginning of a calendar or financial year. Most organisations also have a standard leave application form, which should be adaptable to purchased leave applications.

The scheme normally operates on an annual basis. That means that an employee makes a decision each year whether to apply for purchased leave. If they do not take purchased leave the following year, their remuneration returns to normal.

Taking purchased leave does not affect entitlement to, or accruals of, other forms of leave. It may be joined to other types of leave, for example a period of accrued annual leave may be immediately followed by a period of purchased leave.

All allowances such as entertainment and car allowances remain unchanged when an employee takes purchased leave. Superannuation Guarantee contributions, however, are based on the reduced annual rate of pay.

The bottom line: Purchased leave can be a very effective benefit, highly valued by many employees. However, it is not a matter of employees taking extra leave at short notice when they want to do so; it requires some restrictions and attention to administration to keep it under control.