What Are Accrued Benefits & How Are They Calculated?

Accrued benefits are compensation an employee earns over time but receives at a later date, reflecting value earned beyond a regular salary. These benefits can include retirement funds and paid time off that accumulate with service. The process involves specific rules for when an employee gains full ownership of these earned assets.

Accrual vs Vesting

Accrual and vesting are related processes that govern employee benefits. Accrual is the process of earning a benefit, such as vacation hours, based on service or a set formula.

Vesting is the process of gaining a non-forfeitable right to the benefits that have been accrued. Think of accrual as putting money into a company-controlled safe, while vesting is when the company gives you the key. Employer contributions to a retirement plan are typically subject to a vesting schedule.

Vesting schedules are regulated by the Employee Retirement Income Security Act (ERISA), but rules differ by plan type. For defined contribution plans like 401(k)s, employers may use a “cliff” schedule, where an employee is 100% vested after three years of service, or a “graded” schedule, where vesting is reached after six years. Defined benefit plans can have longer schedules: a five-year cliff or a seven-year graded schedule.

Calculating Accrued Retirement Benefits

The calculation of accrued retirement benefits differs between defined contribution (DC) and defined benefit (DB) plans. For DC plans, like a 401(k), the accrued benefit is the total value of the participant’s account. This includes the employee’s contributions, any employer contributions, and all investment gains or losses.

An employee always has a 100% vested right to their own contributions and the earnings on them. The employer-funded portion, however, is subject to the plan’s vesting schedule. For example, if an employee with a $50,000 account balance leaves while only 60% vested in employer contributions, they can only take their own contributions plus 60% of the employer’s portion and its earnings.

For DB plans, or pensions, the accrued benefit is a promised future monthly payment at retirement, not an account balance. This benefit is calculated using a formula, such as: (Years of Service) x (Final Average Salary) x (Pension Multiplier). An employee with 25 years of service, a final average salary of $80,000, and a 1.5% multiplier would have an accrued annual benefit of $30,000.

The specific elements of the formula, like the period for calculating the final average salary and the multiplier percentage, are unique to each plan. The official source for a plan’s specific formula and rules is the Summary Plan Description (SPD), which must be provided to all participants.

Accrued Paid Time Off

Accrued paid time off (PTO) is vacation, sick, or personal days an employee has earned but not used. Unlike federally governed retirement benefits, PTO rules are determined by state law and individual company policy. The Fair Labor Standards Act (FLSA) does not mandate that employers provide paid time off or pay out unused days upon termination.

Whether a departing employee receives a payout for accrued PTO depends on these rules. Some states require accrued vacation time to be paid out as earned wages. In other states, the employer’s written policy is the deciding factor, and a policy that forfeits unused PTO may be enforceable.

Employees can find the specific rules for their situation in the company’s employee handbook. They should also consult their state’s department of labor website for local regulations.

Accessing Benefits Upon Leaving a Job

When an employee leaves a job, they have several options for their vested retirement benefits. For defined contribution plans like a 401(k), a common choice is a direct rollover into a new employer’s plan or an Individual Retirement Account (IRA). This action preserves the money’s tax-deferred status.

Another option is a lump-sum cash distribution, which requires a 20% federal tax withholding and may incur a 10% early withdrawal penalty if under age 59½. Employees may also leave funds in their former employer’s plan if the vested balance is $7,000 or more. If the balance is between $1,000 and $7,000, the employer may transfer the money into an IRA for the former employee.

For a defined benefit plan, the options are different. The employee typically chooses between receiving their benefit as a lump-sum payout or as a lifelong annuity. An annuity provides a guaranteed stream of monthly payments for life and often includes a survivor option for a spouse.