A federal employee will receive a lump-sum payment for any unused annual leave hours when he or she separates from federal service.
Edward A. Zurndorfer
A federal employee will receive a lump-sum payment for any unused annual leave hours when he or she separates from federal service. Separation from federal service includes leaving federal service before being eligible to immediately retire (this includes leaving under a deferred retirement and a “postponed” retirement) and retiring under an immediate retirement from federal service. A lump-sum payment for any unused annual leave hours equals the pay the employee would have received had he or she remained employed until expiration of the period covered by the annual leave.
Calculating a Lump-Sum Payment for Unused Annual Leave Hours
A federal agency calculates the lump-sum payment of a departing or retiring employee by multiplying the number of hours of accumulated and unused annual leave by the employee’s applicable hourly rate of pay plus other types of pay the employee would have received while on annual leave. The following types of pay are included in a lump-sum payment:
- Rate of basic pay
- Locality pay adjustment
- Within-grade increase (if waiting period met on date of separation)
- Across-the board annual adjustments, and
- Nonforeign area cost-of-living allowances and post differentials.
The following two examples illustrate the calculation of a lump-sum payment for unused annual leave hours:
Example 1. Helen retired from federal service on December 31,2021 with 30 years of federal service under FERS. Helen’s SF 50 salary at the time of her retirement was $172,500. She had a total of 440 hours of unused annual leave hours at the time of her retirement. Effective January 2, 2022, federal employees received a 2.7 percent pay increase. The amount of Helen’s lump-sum payment for unused annual leave hours that she received in January 2022 within a few weeks of retiring from federal service was computed as follows:
Step 1: Compute Helen’s hourly wage rate as of the day of her retirement:
- $172,500/2087 hours* equals $82.65/hour
* Full time employees work 2087 hours per leave year
Step 2: Multiply the number of hours of unused annual leave by the hourly wage rate had Helen been on annual leave and did not retire:
- Multiply $82.65 by the government-pay increase for federal employees effective January 2, 2022
- $82.65/hour x 1.027 equals $84.88/hour
- 440 hours of unused annual leave hours times $84.88/hour equals lump-sum payment of $37,347.20
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Example 2. Frank retired from federal service on July 30,2022 at age 62 with 25 years of federal service under FERS. Frank’s SF 50 salary at the time of his retirement was $153,560. He had a total of 330 hours of unused annual leave hours at the time of his retirement. Frank was not due for any within-grade increases in the near future nor was there any government-wide pay increase in the period had Frank used his annual leave hours had he not retired. Frank’s lump-sum payment for unused annual leave hours that he received in August 2022 was computed as follows
Step 1. Compute Frank’s hourly wage rate as of the day of retirement:
- $153,560/2087 hours* equals $73.58/hour
* Full time employees work 2087 hours per leave year
Step 2. Multiply the number of hours of unused annual leave by the hourly wage rate had Frank been on annual leave and did not retire:
- $73.58/hours x 330 hours equals lump-sum payment of $24,281.17
Taxation of Lump-Sum Payment for Unused Annual Leave Hours
The lump-sum payment for unused annual leave hours is fully taxable, subject to federal and state income taxes, and Social Security (FICA) and Medicare Part A (Hospital Insurance) payroll taxes. Note that a retiring employee’s payroll processing office makes the lump-sum payment and directly deposits the payment into the same bank account that the retiring employee has his or her bi-weekly paychecks directly deposited. No other deduction besides income taxes and payroll taxes are made from the lump-sum payment. A retiring employee cannot request that a portion of the lump-sum payment be contributed to the Thrift Savings Plan or to an IRA.
At the point of the calendar year a retiring employee’s total wages (including cumulative bi-weekly salary and the amount of payment for unused annual leave hours) exceeds the maximum Social Security wage base for that year, the payroll processing office will then not withhold Social Security (FICA) tax. In other words, if an employee retires at the time of a calendar year at which the employee’s reached the maximum Social Security wage base, then no FICA tax will be deducted from the retiring employee’s lump-sum payment for unused annual leave. This assumes that the lump sum payment will be paid and directly deposited into the retiring employee’s bank account within the same calendar year. For calendar year 2022, the maximum Social Security wage base is $147,000. For calendar year 2023, the maximum Social Security wage base will be $160,200.
How Returning to Federal Service Affects the Lump-Sum Payment
In calculating a lump-sum payment, an agency projects forward an employee’s annual leave for all the workdays the employee would have worked if he or she had remained in federal service. By law, holidays are counted as workdays in projecting the lump-sum period. If a departed or retired employee is reemployed into federal service prior to the expiration of the period of the lump-sum unused annual leave period, then he or she must refund the portion of the lump-sum payment that represents the period between the date of reemployment and the expiration of the lump-sum period. An agency recredits the employee’s leave account the amount of annual leave equal to the days of work remaining between the date of reemployment and the expiration of the lump-sum period. The following example illustrates:
Example 3. Same facts as in Example 2 except that Frank returns to federal service as a rehired annuitant after being retired for six weeks (240 hours). Since Frank was paid in a lump-sum for a total of 330 hours of unused annual leave hours and was retired for 240 hours, he must pay back to his agency the excess 330 less 240, or 90 hours. He owes the agency the following amount:
- 90 hours x $73.58/hour, or $6,622.20
After Frank pays back the $6,622.20, his annual leave account will be credited for the 90 hours of unused annual leave.
Edward A. Zurndorfer is a Certified Financial Planner, Chartered Life Underwriter, Chartered Financial Consultant, Chartered Federal Employee Benefits Consultant, Certified Employees Benefits Specialist and IRS Enrolled Agent in Silver Spring, MD. Tax planning, Federal employee benefits, retirement and insurance consulting services offered through EZ Accounting and Financial Services, and EZ Federal Benefits Seminars, located at 833 Bromley Street – Suite A, Silver Spring, MD 20902-3019 and telephone number 301-681-1652. Raymond James is not affiliated with and does not endorse the opinions or services of Edward A. Zurndorfer or EZ Accounting and Financial Services. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. While the employees of Serving Those Who Serve are familiar with the tax provisions of the issues presented herein, as Financial Advisors of RJFS, we are not qualified to render advice on tax or legal matters. You should discuss tax or legal matters with the appropriate professional.