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What Happens to Unused Annual Leave When a Federal Employee Leaves Service?

Edward A. Zurndorfer, Edward A. Zurndorfer, Certified Financial Planner

Upon leaving federal service, a federal employee is entitled to a lump-sum payment for any accumulated and unused annual leave.

"Leaving" federal service includes retiring from or quitting federal service or leaving one's job temporarily to go on military leave. This column discusses what the lump-sum payment is, how it is computed, how much employees should expect to receive, and when it is paid.

Full- and part-time employees are eligible for the lump-sum payment. A lump-sum payment for unused annual leave is in general equal to the "pay" an employee would have received had he or she remained in federal service until the expiration of the period of unused annual leave.

The following types of pay are included in the computation of the lump-sum payment:

  1. "basic" pay;
  2. locality pay adjustments;
  3. within grade increases, if waiting period is met on day of separation;
  4. across-the-board annual adjustments;
  5. where applicable, availability pay for law enforcement;
  6. regularly scheduled overtime pay under the Fair Labor Standards Act for employees on uncommon tours of duty;
  7. supervisory differentials; 
  8. non-foreign area cost-of-living allowances and post differentials;
  9. foreign area post allowances; 
  10. night differential for Federal Wage System employees only.

The lump-sum payment comes from the departing or retiring employee's payroll office and not from the Office of Personnel Management (OPM). The check will be deposited directly into the same bank account as the employee's paycheck was deposited. The departing or retiring employee should expect the check to be deposited within two to four weeks after leaving federal service.

An agency calculates a lump-sum payment by multiplying the number of hours of accumulated and unused annual leave by the departing employee's applicable hourly salary rate. For example, if an employee's salary is $80,000 per year, then the employee's hourly salary rate is $80,000/2,087 hours per leave year, or $38.33 per hour. If, for example, the employee has 300 hours of unused annual leave at the time or retirement/departure from federal service, the employee's lump-sum payment will calculated as 300 hours multiplied by $38.33/hour, or $11,499. The lump-sum payment is subject to taxes - federal and state income taxes, Social Security (FICA), and Medicare Part A payroll taxes. CSRS or FERS contributions, insurance premiums and TSP contributions are not deducted.

As noted earlier, the lump-sum payment must equal the pay an employee would have received had the individual remained in federal service. The employee's agency will "project" the lump-sum period of leave beginning on the first workday after the day the employee leaves or retires from federal service. This means that the projection includes all subsequent workdays and holidays until the expiration of the period of unused annual leave. Note that holidays are paid as regular workdays. Here is an example.

Carol retired on Dec. 31, 2008 with 400 hours or 50 days of unused annual leave. Carol's lump-sum payment will be paid as if she had work the following days: January 1- 2, January 5 - 9, January 12 - 16, January 19 - 23, January 26 - 30, February 2 - 6, February 9 - 13, February 16 - 20, February 23 - 27, March 2-6, March 9-11, a total of 50 days.

Note that since the government-wide pay increase and locality pay adjustment took effect on January 4, 2009, Carol's lump-sum payment for the period January 5 through Mar 11, 2009 (a total of 48 days) will include the government-wide  pay increase and locality pay adjustment. Also, note that both January 19 and February 16 are federal holidays that are paid as regular workdays and not as holidays.
The lump-sum payment is taxable in the year it is received. For example, if an employee were to retire on Dec. 31, then the lump-sum payment for unused annual leave will be directly deposited in the retired employee's bank account by mid- to late January. That means the lump-sum payment is taxable in the new calendar year. The former employee will also have the lump-sum payment reported on a W2 form for the year in which it is received.

The maximum number of hours of unused annual leave payable to non-Senior Executive Service employees or to those employees who never worked overseas is 448 hours. This could be accomplished by:

  1. carrying over 240 leave hours from one leave year to the next;
  2. retiring at the end of pay period 26 and before the start of the new leave year (in most leave years there are 26 pay periods);
  3. not using any annual leave hours during the last year of employment, thereby accruing 26 pay periods times eight hours per pay period or 208 hours of annual leave, added to the 240 hours carried over from the previous leave year, resulting in a total of 448 hours. Note that if an employee retires before the end of pay period 26 (for example, December 31, 2008), then the lump-sum payment will include 440 hours of unused annual leave.

Agencies will withhold federal (and state, if applicable) income taxes from the lump-sum payment at the same withholding rate as they did on the employee's paycheck. An employee who wants to have less or more federal (and state) income taxes withheld should fill out a federal income tax withholding certificate (W4 and the equivalent for state income tax withholding) within two to three weeks prior to departing from federal service.

There is also the issue of the Social Security (FICA) maximum taxable earnings base that affects both FERS and CSRS Offset employees. Earned income - that includes bonuses, salary or wages, and the lump-sum payment - during 2009 in excess of $106,800 is not subject to the 6.2 percent FICA withholding. This means that there could be a savings of 6.2 percent of salary - including the lump-sum payment - for any FERS or CSRS Offset employee whose earned income exceeds $106,800 in 2009.

If an employee earning more than $106,800 during 2009 were to leave or retire from federal service at the end of October rather than at the end of December and receive the lump-sum payment in calendar year 2009, then a portion - perhaps all - of the lump-sum payment would not be subject to the 6.2 FICA tax. But a disadvantage to retiring in late October rather than late December is that the employee will lose five or six accrual periods of additional annual leave hours; also the lump-sum payment will be paid at the current leave year's hourly rate rather than the new leave year's higher hourly rate. This is because unused annual leave is projected into future work days. An employee's departure or retirement at the end of December or at the beginning of January will result in the employee's having the unused annual leave paid at the new leave year's hourly rate after the pay increases take effect of the first day of the new leave year.

If an employee returns to federal service prior to the expiration of the period of the lump-sum annual leave period, he or she must refund the portion of the lump-sum payment that represents the period between the date of re-employment and the expiration of the lump-sum period. The employee's agency will then re-credit to the employee's leave account the amount of annual leave equal to the days or hours of work remaining between the date of re-employment and the expiration of the lump-sum leave period.


About the Author

Edward A. Zurndorfer is a Certified Financial Planner, Chartered Financial Consultant, Chartered Life Underwriter, Registered Health Underwriter, Registered Employee Benefits Consultant and Enrolled Agent in Silver Spring, MD -- and the owner of EZ Accounting and Financial Services, an accounting, tax preparation and financial planning firm also located in Silver Spring, MD.  Zurndorfer is also is an instructor at federal employee retirement seminars throughout the country and writes numerous columns and books on federal employee benefits.