Paying your employees and contractors accurately and on time is a painless way to keep moralehigh and retain the talent that makes your company successful. Many businesses find directdeposit a reliable means to automate payroll functions, stay in compliance with tax laws andensure workers can promptly access their funds on payday.
But there are gotchas to watch for, like more difficulty switching financial institutions orupdating payment errors. So is direct deposit right for your business? Here’s a guideto howthe process works, a checklist to set up direct deposit, and a rundown of benefits anddrawbacks.
What Is Direct Deposit?
Direct deposit replaces older payment methods, such as issuing paper checks and envelopes ofcash. By electronically transferring funds from your company’s bank account to youremployees’ accounts, you minimize risk and set your payroll team up for success.
You may also hear direct deposit referred to as direct pay, electronic funds transfer (EFT)or electronic checks. Whatever the term, most businesses choose to pay their employees usingthis option, with 94% ofworkers receiving their pay through direct deposit .
Key Takeaways
- Direct deposits are widely used as a convenient, time-saving and cost-effective way topay employees.
- Direct deposit is also generally safer for both employers and workers than paying bycheck or cash.
- There are a few drawbacks: It’s more difficult to change banks and to stop oradjusterroneous payments than when issuing a check.
- Direct deposits can also be used for payments to contractors and for bonuses, annuitiesand travel expenses.
Direct Deposits Explained
Direct deposits move funds between banks over a centralized electronic payment network calledthe Automated Clearing House (ACH) network. A bank-funded nonprofit organization calledNacha—which was established as the National Automated Clearing HouseAssociation—manages theadministration, development and governance of the ACH network.
Nacha facilitates information-sharing among regulatory bodies and financial institutions. Italso focuses on reducing risk and fraud with the goal of keeping banks, employers andworkers confident in the direct deposit system.
How Does Direct Deposit Work?
As an employer, you’ll get started by setting up direct deposit with your bank or apayrollservice provider and connecting your accounting system.
You’ll need information about the account that will be used to pay employees and thecheckingor savings account numbers for the accounts into which each worker or contractor wants payto be deposited.
Then, for each payroll run, you provide your bank or payroll service with directdeposit instructions listing the amount to be transferred to each employee’s account.Yourbank or provider sends the direct deposits to the ACH network, which directs them to youremployees’ banks. The receiving banks then credit your employees’ accounts.Funds areimmediately available to your employees once payment posts.
ACH payments generally take one to two business days to close. The ACH network also supportssame-day payments, which usually involve an additional fee.
Can Small Businesses Use Direct Deposit?
Businesses of any size can use direct deposit—the payroll process is essentially thesamewhether you have 10 employees or 10,000. And in fact, payroll often emerges as a pain point assmall companies add workers. Direct deposit helps remove that barrier to growth and putsyour firm on an equal footing with larger companies come hiring time.
Advantages of Direct Deposit
Direct deposit is easy, safe and cost-effective. It also makes cash flow more predictablecompared with paying employees with paper checks.
Many of the benefits of direct deposit apply both to your company and to your employees.Let’s look at it from both angles.
Benefits of direct deposit for your business
Save time: Because direct deposit is automatic, ittakes less time to process payroll. You’ll reduce bookkeeping hours because youdon’t needto write, mail and reconcile checks—or reissue lost checks. And, you’ll minimizepayroll-related accountingissues like delays updating the general ledger and time spent on manualreconciliations.
Save money: Besides finance team time savings, you’ll eliminate thecostsof checks, postage and other mailing supplies required for a paper-check-based process.Reissuing lost checks may incur fees from banks or payrollservices. And, payroll services can ensure your company accurately retains tax andother deductions, and thus avoids penalties.
Improve cash flow projections: Minimizing cash flow problems isparamount for any business. With direct deposit, you know exactly when payments to employeeswill be withdrawn from your bank account, and the exact amount. This means you canaccurately predict cash requirements. In contrast, when paying by check, your cash flow willdepend on when employees choose to cash their paychecks.
More secure than paper checks: Direct deposits are generally consideredsafer than issuing checks, which can be lost, stolen or forged. Nacha reports that payrollimpersonation fraud, where a criminal targets an employee by sending a phishing email thatimpersonates the employer’s human resources or payroll department, is a real concern.
5 Steps to Keep Payroll Safe
| Criminals may trick employees to log in to a fake website so they canhijack payroll data, including bank accounts. They use that informationto steal funds or reroute payments. Here’s how to keep workerssafe: |
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| Train staff on how phishing attacks work and ways to recognizesuspicious links. Warn employees to be wary of emails purporting to comefrom your finance team or payroll service provider. |
| Provide a contact where employees can forward suspicious emails;consider rewarding workers who spot and report phishing attempts. |
| Implement a policy that payroll self-service portals will requireauthentication for requests to change payment information and willreauthenticate users accessing the system from unrecognized devices. |
| Set up automated alerts for payroll administrators so that unusualactivity—like when banking information is changed or multiplechangesthat use the same new routing number or identical accountnumbers—may becaught before money is lost. |
| Validate employees’ new direct deposit information by sending ACHprenotification transactions. |
Process anytime/anywhere: Once you’ve set updirectdeposit, you’ll be able to pay your employees with a few clicks. Whether you’rein theoffice, working from home or travelling, your employees will still be paid on time. Notethat, for companies that have human resources teams, it’s good practice to unite HR and payroll systems fromthe get-go so that the payroll process can be run and data updated by more than one group.
Help the environment: If environmentally friendly practices are importantto your business, then direct deposit is the way to go. You’ll save trees and reducegreenhouse gas emissions by eliminating the need to print and deliver checks.
Benefits of direct deposit for your employees
Save time: Most employees like getting their payautomatically deposited in their accounts. They don’t have to worry about picking upchecks,running to the bank or waiting for checks to clear. They enjoy rapid access to their funds,since their money is always available on payday, even if they’re sick or on vacation.
Save money: Some banks offer free checking accounts if they know accountholders will receive their pay via direct deposit and meet other conditions, such asmaintaining a minimum monthly balance.
Simpler expense reimbursem*nts: You can include expense reimbursem*ntsthrough direct deposit simplifies the process for employees and employers.
More secure than paper checks: Employees no longer need to worry abouttheir checks being lost or stolen.
Choose where the money goes: Some banks and payroll providers enableemployees to split their direct deposit among multiple accounts, so they can direct part ofit into a savings account every month.
Disadvantages of Direct Deposit
Although direct deposit is more efficient than paying by check, there are some drawbacks forboth employers and employees.
Disadvantages of direct deposit for your business
Time-sensitive: To ensure payments reachemployees’bank accounts on payday, you need to run payroll one to two days in advance—regardlessofhow many other priorities you’re juggling. If you fail to do so, you’ll haveunhappyemployees.
Potential security risks in housing employee bank data: To enable directdeposits to employees, you need to store their bank account and routing information. Ensurethat you have adequate security measures and policies in place to protect their sensitivefinancial data—it’s not unheard of for finance employees to be targeted by scammers.
Fewer “stop payment” options than with paper checks: It can bemoredifficult to stop or reverse direct-deposit payments than when paying by check. If youaccidentally overpay an employee, you can generally reverse the payment as long as you do sowithin five days, but some states apply additional restrictions once the money has reachedemployees’ bank accounts.
Potential bank and overdraft fees: Banks generally charge employers feesfor direct deposit payments. And if you don’t ensure your account contains all thefundsrequired for a payroll run before payday, you may incur expensive overdraft fees.
Disadvantages of direct deposit for employees
Bank account fees: If employees don’t alreadyhave abank account for receiving direct deposits, they may need to open one and pay monthlyaccount maintenance fees. As an employer, you may consider offering education and referralsto institutions that will offer free checking, or even provide membership in a credit unionas a benefit.
Makes changing banks harder: If employees change banks, they’ll havetorepeat the initial direct deposit setup process, which can take several days.
Potential security risks. Your employees are entrusting your company, oryour payroll service provider, with sensitive financial information, potentially creatingnew risks including identity theft if the information isn’t well guarded.
Pros and Cons of Direct Deposit
PROs | CONs |
| Convenient for employers and employees | Time-sensitive—you must schedule payments in time to reachemployees’accounts on payday |
| Time-saving and cost-effective for employers | Bank setup and transaction fees |
| Less chance of fraud or lost payments than with checks | Data security concerns |
| Employees have fast access to wages | Hard to stop payments if errors are found |
| Environmentally friendly | More difficult to change banks |
How Much Does Direct Deposit Cost?
There are several costs to consider. Banks generally charge an initial setup fee of $50 to$149 plus transaction fees averaging from $1.50 to $1.90 for each individual deposit. Somebanks may also charge monthly fees.
We say “generally” and offer a range because the fee structure depends on thesize of yourbusiness, your bank, whether you process payments yourself or use a service and yourspecific direct deposit agreement. It’s worth comparing prices among differentfinancialinstitutions and payroll service providers.
When Do Payroll Deposits Post for Employees?
With next-day ACH payments, payroll deposits are posted and available to your employees asearly as 9:00 a.m. or as late as 5:00 p.m. local bank time on payday, depending on when thereceiving bank receives funds. If the receiving bank receives funds by 5:00 p.m. local time,the money will be in employees’ accounts by the following morning.
Under same day ACH, employees are paid by 5:00 p.m. on the same day that you transfer funds,provided you meet specific deadlines set by your bank and the ACH network. Banks generallycharge extra for same-day ACH payments.
How Does Paying Contractors Work?
If you work with many independent contractors, it’s worth keeping your options open inregardto direct deposit. If you’re using payroll software or an outsourced payroll service,checkto make sure the system supports payments to contractors as well as employees—thoughindependent contractors are usually paid through accounts payable, not payroll. ACH can alsobe used for direct deposit through accounts payable.
Although the direct deposit payment process for contractors is generally the same as foremployees, you will need to maintain different paperwork. When you hire an independentcontractor or firm, they’ll complete a W-9 tax form instead of the W-2 that employeesuse.If you pay a contractor $600 or more per year, you’ll need to provide a 1099 form atthe endof the year.
How to Set up Direct Deposit for Your Small Business
You’ll need to go through five initial steps to set up direct deposit. It’simportant to notethat the setup process can take seven to 10 business days, so plan accordingly to ensurethere’s no disruption to your employees’ pay cycle.
Select a direct deposit provider: You have a number of options here.You can set up direct deposits directly with your financial institution, or you canuse payroll software or a payroll service that will handle the direct deposits foryou. Take the time to understand and compare the options, including costs, securityfeatures and payment processing times. Your chosen provider should walk you or yourHR or finance team through the setup steps. Be sure to run test transactions toensure the direct deposit process is running smoothly.
Obtain required employee information: After the setup and test phaseis complete, it’s time to load employee data into your system. Employersgenerallyneed to obtain the following information from employees, although the requirementsmay vary by state:
- Bank account number
- Type of bank account (checking, savings)
- Bank routing number
- Bank name
- Employee signature authorizing the deposit of funds in the account(s)
Some providers also request a copy of a voided check to ensure the accuracy of thebank information.
Enter employee information into your system: If you’re usingyourbank to process direct deposit, you’ll either have to manually enter theinformationinto your bank’s online portal, or you may be able to export the informationfromyour payroll system.
If you’re using payroll software or a service, employees can generally entertheirown information, including the data on deductions and residency you need to calculate payrolltaxes, and supply the necessary authorization.
- Create a payroll direct deposit schedule: Create a schedule thatincludes a deadline for entering employees’ hours worked and provides enough timetoreview the data, process payroll and meet direct deposit transfer deadlines.
- Run payroll: It’s time to send your first set of direct depositinstructions. Your upfront time investment in the initial setup will be rewarded byincreased automation and convenience on each payroll run.
What Else can Direct Deposit be Used for?
Once you get direct deposit set up the system can be used for a variety of other payments,including:
- Bonuses and commissions
- Annuities
- Reimbursem*nts for travel and otherexpenses
- Interest payments/dividends
- Pensions and 401(k) disbursem*nts
- Tax and other refunds
Again, you’ll enjoy the cost savings, security and other benefits of direct deposit andhavean easily accessible record of these outlays for general ledger and audit purposes.
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Payroll Software and Direct Deposit for Small Businesses
Managing payroll can be an extremely time-consuming and complex process, and it’scritical toget it right. Payroll software can relieve companies of mostof the burden by automatically calculating wages and tax withholding, filing taxes andpaying employees by direct deposit or other methods.
Features that growing businesses should look for include links to other systems, like HR andERP, as well as security roles and alerts that will helpguard against data theft.
Paying employees and contractors with direct deposit does require an initial investment inresources, time and planning. But once established, you will enjoy the speed, accuracy andsafety of automated payments while having one more touchpoint when competing for talent.
Direct Deposit FAQs for Small Businesses
Is direct deposit safe?
Direct deposit is one of the safest ways to pay employees because moneyis transferred directly into their bank accounts through the secure ACH Network.
How reliable is direct deposit?
Direct deposit is automated and highly reliable, as long as employersand banks meet the ACH payment transfer deadlines.
Can an employer require an employee to use direct deposit?
It depends on location. Federal law permits mandatory direct depositas long as the employee can choose which bank should receive the deposit. However, somestates require employee consent or impose other conditions.
What types of payment can be made by direct deposit?
Direct deposits can be used to pay employee’s salary, expenses,commissions, bonuses, tax refunds, investmentredemptions, payments from retirement accounts, and governmentbenefits such as Social Security.
Do I have other options besides direct deposit?
Yes, companies may pay employees with pay cards that are essentiallydebit cards onto which you deposit funds. But be aware of state lawsgoverning these cards.
In addition, in 2015, the U.S. Federal Reserve created the Faster Payments Task Force to makerecommendations about developing methods to support faster payments, including for payroll,by modernizing the ACH system.
