When Employers Can Pay Out Annual Leave And How To Calculate It

As a small business owner, annual leave might feel straightforward day-to-day - until you hit the moments where things get tricky: an employee resigns, you terminate employment, or someone asks whether they can have their annual leave paid out instead of taking time off.

This is where paying out annual leave becomes a practical (and legal) issue. If you get it wrong, you can end up with underpayments, payroll disputes, or Fair Work compliance problems - all of which can be time-consuming and expensive to fix after the fact.

In this guide, we’ll walk you through when annual leave can be paid out in Australia, how an annual leave pay out is usually calculated, and what you should do as an employer to handle it properly.

What Is A Payout Of Annual Leave (And When Does It Come Up)?

A payout of annual leave is when an employee is paid money for annual leave entitlements instead of (or in addition to) taking the leave as time off work.

In practice, annual leave may be paid out in two common situations:

• When employment ends (for example, resignation, termination, redundancy): unused annual leave must generally be paid out.
• While employment continues: annual leave can sometimes be “cashed out”, but only if strict rules are followed.

From an employer’s perspective, the key is understanding that the rules are different depending on why the annual leave is being paid out. What’s allowed for a final pay is not always allowed while someone is still employed.

If you want a refresher on what annual leave is and how it’s usually paid, it can help to also read annual leave payments.

When Should Annual Leave Be Paid Out In Australia?

If you’re wondering “when should annual leave be paid out?”, the answer depends on whether the employee is leaving your business, or staying.

1. Annual Leave Paid Out When Employment Ends

In most cases, if an employee has unused annual leave when their employment ends, you need to pay it out as part of their final pay.

This usually applies regardless of how the employment ends, including:

• the employee resigns
• you terminate their employment (with or without notice, depending on the circumstances)
• redundancy
• the end of a fixed term (where applicable)

Put simply: if annual leave is owed at the end of employment, you generally don’t get to “keep” it - it becomes a payment obligation.

For resignation-specific issues (like timing, notice periods and final pay obligations), annual leave on resignation is worth reviewing.

2. Can Annual Leave Be Paid Out During Employment?

This is where employers need to be careful. Many business owners ask: can you get your annual leave paid out while you’re still employed?

Generally, annual leave is meant to be taken as time off so employees can rest and recover. However, some employees (and employers) prefer flexibility, especially where someone has built up a large leave balance.

Whether annual leave can be paid out during employment usually depends on:

• the employee’s industrial instrument (such as a modern award or enterprise agreement), and
• whether your business has followed the required cashing out process (including written agreements and minimum leave balance requirements).

Some modern awards and enterprise agreements allow annual leave to be cashed out, but only if certain conditions are met. Common requirements include that the employee keeps a minimum balance (often at least 4 weeks after cashing out) and that cashing out is genuinely voluntary.

If your employee is asking for a leave pay out while still employed, check their award or agreement first, then document the arrangement properly. You can also refer to cashing out annual leave for an overview of how this works in Australia.

3. Can You “Force” An Employee To Cash Out Annual Leave?

In most cases, no. Cashing out annual leave is usually a voluntary arrangement and needs to be agreed in writing.

That said, employers can often direct employees to take annual leave in certain circumstances (for example, where the leave balance is excessive, or during a shutdown period), but this is different to paying it out. Direction to take leave must still be lawful and reasonable and comply with any award/enterprise agreement and the National Employment Standards (NES).

If you’re considering implementing a “use it or cash it out” approach, it’s a good idea to get specific advice first - because the compliance risk can be high if the arrangement isn’t permitted for that employee.

How To Calculate A Payout Of Annual Leave (With Examples)

Calculating an annual leave pay out sounds simple - “hours owed x hourly rate” - but small differences in pay structure can change the outcome.

As a starting point, you should calculate annual leave based on what the employee would have been paid if they took the leave. Depending on the applicable award, enterprise agreement or contract, this is often described using concepts like the employee’s base rate of pay or their ordinary pay for ordinary hours.

Step 1: Confirm The Employee’s Unused Annual Leave Balance

First, confirm the unused annual leave balance in hours (or days). This should come from your payroll system, timesheets, or leave records.

It’s worth double-checking this before processing final pay, especially if:

• your employee’s hours changed over time (for example, full-time to part-time)
• you’ve had payroll system changes
• the employee took leave at half pay or purchased leave arrangements exist
• leave was accrued but not correctly recorded

Step 2: Work Out The Correct Rate Of Pay For Annual Leave

Unused annual leave is generally paid based on what the employee would have received for their ordinary hours if they had taken the leave. For many employees, this will effectively be their base hourly rate.

For salaried employees, you’ll usually need to convert their salary to an hourly rate (based on their ordinary hours) to calculate the payout value.

Where an award or enterprise agreement applies, it may also specify exactly what components of pay are included (or excluded) when paying annual leave, so it’s important to check the relevant instrument rather than assuming it’s always “base rate only”.

Step 3: Consider Leave Loading (If It Applies)

Some awards and agreements include annual leave loading (often 17.5%). If leave loading applies, it may also apply to the payout of unused annual leave - including when leave is paid out on termination.

This is a common area where underpayments occur, because not every employee receives leave loading, and not every workplace instrument treats it the same way.

If your employee is award-covered, you should check their award conditions carefully before finalising the leave pay out.

Step 4: Be Cautious With Overtime, Allowances And Bonuses

In many cases, annual leave payouts are based on ordinary hours and ordinary pay rather than overtime. Some allowances may or may not be included depending on the nature of the allowance and the employee’s industrial instrument (and in some cases, how the allowance is ordinarily paid when the employee takes leave).

Because this can vary, the safest approach is:

• check the relevant award/enterprise agreement/employment contract terms, and
• ensure your payroll approach matches how leave would have been paid if it was taken (not paid out).

Example: Annual Leave Paid Out On Termination (Hourly Employee)

Let’s say your employee:

• has 38 hours of unused annual leave
• is paid $32 per hour base rate
• does not receive leave loading

The annual leave pay out would typically be:

38 hours x $32 = $1,216

Example: Annual Leave Pay Out With Leave Loading

Same example, but leave loading applies at 17.5%:

• Base leave payout: $1,216
• Leave loading: $1,216 x 17.5% = $212.80

Total annual leave pay out: $1,428.80

Remember: whether leave loading applies to a payout depends on the employee’s minimum entitlements (award/enterprise agreement) and any over-award arrangement in the contract or policy.

What About Tax And Super?

Final pay, including unused annual leave, is taxed according to ATO rules and the type of payment.

Superannuation treatment can also differ depending on whether leave is paid out on termination or cashed out during employment.

Sprintlaw can help you understand your legal obligations as an employer, but we don’t provide tax or accounting advice. For the correct tax and super treatment in your specific circumstances, it’s best to check the ATO guidance and/or confirm the approach with your accountant or payroll provider.

What Employers Need To Do When Paying Out Annual Leave

Even when you’ve calculated the amount correctly, there are still practical compliance steps to get right. As a small business, your goal should be to have a repeatable offboarding (or cash-out) process that reduces mistakes and keeps records clean.

1. Identify The Legal Basis For The Payment

Before you process the payment, clarify which situation applies:

• Final pay (employment ending) - unused annual leave must usually be paid out.
• Cashing out (employment continuing) - only allowed if the relevant rules are met and documented.

If you don’t clearly identify this at the start, it’s easy to miss steps like the written agreement for a cash out, or misapply the rate of pay.

2. Calculate Final Pay Items Together (Not In Isolation)

Annual leave is often just one part of final pay. Depending on the circumstances, final pay can also include:

• wages up to the last day of employment
• unused annual leave payout
• unused long service leave (where applicable)
• payment in lieu of notice (if the employee won’t work their notice period)
• redundancy pay (if redundancy applies and no exemption applies)

It’s much safer to treat final pay as one calculation exercise, rather than paying bits and pieces across different dates.

If you are paying out notice instead of requiring the employee to work it, payment in lieu of notice can be a helpful reference point.

For a broader employer-focused approach, calculating final pay is also useful for planning your offboarding process.

3. Pay It On Time

One of the most common disputes we see is not about whether annual leave should be paid out - it’s about when.

As a general rule, final entitlements should be paid promptly. The required timeframe may also be affected by the employee’s award, enterprise agreement, or employment contract terms.

If you delay final pay, you can create unnecessary conflict right at the end of an employment relationship, and you increase the risk of a complaint or claim.

4. Issue A Proper Payslip And Keep Records

When annual leave is paid out (whether as final pay or cashed out), you should ensure:

• the payslip clearly shows the annual leave payout amount and how it’s categorised
• your payroll records reflect the leave balance reduction
• you keep relevant supporting documentation (especially if cashing out annual leave during employment)

Good record-keeping is not just “admin” - it’s part of your compliance position if you’re ever audited or if an employee challenges their final pay.

5. Make Sure Your Employment Documents Support Your Process

Many payout issues start much earlier than termination. They can come from unclear employment terms, inconsistent payroll practices, or leave policies that don’t match what the employee is actually entitled to.

It’s worth ensuring your Employment Contract and workplace policies clearly explain how leave accrues, how leave is requested and approved, and what happens at the end of employment.

This won’t override minimum legal entitlements - but it can reduce confusion and help you run a consistent, defensible process as your team grows.

Common Mistakes Small Businesses Make With Annual Leave Paid Out

If you’re trying to reduce risk, it helps to know the common pitfalls we see when employers handle the payout of annual leave.

Paying The Wrong Rate

This can happen when:

• the employee’s ordinary hours changed, but the payroll settings didn’t
• leave loading applies, but wasn’t included
• the employee is covered by an award and an award-specific rule about how annual leave is paid was missed

Cashing Out Leave Without A Valid Written Agreement

If you allow annual leave to be paid out during employment without following the correct process, it can lead to backpay risk - even if the employee requested it and was “happy at the time”.

Delaying Final Pay

Even a small delay can create a disproportionate dispute, particularly where the employee is counting on their final pay or there’s already tension at the end of employment.

Mixing Up Annual Leave Payout With Other Entitlements

Annual leave payout often sits alongside other final pay items, and each category can have different rules. If you need to sanity-check your broader approach to leave, you can also review annual leave on resignation to help keep your termination/resignation process compliant.

Key Takeaways

• The payout of annual leave most commonly happens when employment ends, and unused annual leave generally needs to be paid out in final pay.
• Annual leave can sometimes be paid out during employment (cashing out), but only if the employee’s award/enterprise agreement allows it and you follow the correct process.
• To calculate an annual leave pay out, confirm the unused leave balance, apply the correct rate of pay (as required by the NES and any applicable award/enterprise agreement), and check whether leave loading applies.
• Final pay often includes multiple components (like wages, annual leave payout, and possibly payment in lieu of notice), so it’s best to calculate everything together and pay it promptly.
• Clear contracts, consistent payroll practices, and good records help prevent disputes and reduce the risk of underpayments.

If you’d like help reviewing your annual leave payout process or your employment documents, you can reach us at 1800 730 617 or team@sprintlaw.com.au for a free, no-obligations chat.