Even if you work hard, live within your means, and do your best to save money, you can still find yourself in a financial bind. Recent surveys suggest that most American workers live paycheck to paycheck, and many are one medical emergency, automobile repair bill, or faulty furnace away from a true financial crisis.
What are your options? Carrying a credit card balance, refinancing a mortgage, or obtaining a home equity loan could work for some, but taking on these types of debt could also make your financial situation much worse in a hurry. And not everyone owns a home or can qualify for a second mortgage.
If you find yourself in an unexpected financial bind you might be able to borrow money from your employer. However, before you approach your employer it’s important to understand your options.
Payroll Advance
A payroll advance is basically a loan against your earnings. Your employer will release payroll funds early and recoup this money through future deductions to your paycheck. This can be tricky because payroll advances are regulated by both federal and state law.
The Fair Labor Standards Act (FLSA) is a federal law that protects workers from unfair labor practices by establishing a minimum wage, setting overtime pay standards, and regulating child labor. Under the FLSA, repayment deductions for payroll advances cannot drop the employee’s paycheck below the minimum wage. As a result, your repayment deductions may have to be spread out over several paychecks (29 U.S.C. § 211 and following).
In addition, payroll advances are often regulated by state law. Most states, for example, require these types of agreements to be in writing.
When a Payroll Advance Might Make Sense
Taking a payroll advance can be the right move in certain situations. Some reasons a payroll advance might work for you:
- The amount of money you need is small, relatively speaking. In other words, a payroll advance only helps if you can afford future payroll deductions without making your situation worse.
- There is no credit check. Unlike traditional loans, poor credit will not prevent you from getting temporary relief.
- Generally, your employer cannot charge interest on your loan. You might be required to cover some administrative and record keeping costs caused by the advance, but in most cases your employer cannot profit from this arrangement.
- Unlike traditional loans such as a mortgage or financing a car, a payroll advance is unsecured. In other words, there is no collateral at stake if you cannot repay the loan before you leave your job. Your employer, however, could recoup the loan balance from your final paycheck.
Employee Loan
A loan is another way to borrow money from your employer. As with a payroll advance, one perk is that your employer might be willing to help even if your credit is poor.
However, keep in mind that an employee loan is like a traditional loan: Your employer can charge interest and for loans over $10,000 the rate must be as high as the Applicable Federal Rate.
Your employer could also require you to sign a promissory note that details the amount borrowed, the repayment terms, the interest rate, and your employer’s rights and remedies in the case of default. Violating the terms of the note creates legal liability that could last beyond your last day of work should your relationship with your employer end.
Borrowing from a 401(k) Plan
Technically, you will not be borrowing money from your employer. Rather, you will be borrowing money from your future self. But this sort of loan is worth considering if your 401(k) plan permits it.
Keep in mind that is not an early withdrawal. Instead, you're taking money out of your 401(k) account and repaying it with interest. Generally, the maximum loan amount is $50,000 or 50% of your vested income, and you need to pay it back within five years. The maximum repayment period can be accelerated, however, if you leave your job.
Borrowing money from your retirement plan is also highly regulated and can be complicated. For more information on this, the Internal Revenue Service (IRS) is a good place to start.
Consider your Employer’s Perspective
It’s important to understand that you might not get everything you need from your employer. Try not to take it personally. Employers are not required by law to give payroll advances or employee loans, and the amount your employer is willing to loan could be limited. Some reasons for this include:
- There’s financial risk to your employer. In the case of a loan, there’s always the risk it will not be repaid. As a result, your employer may have an eligibility policy in which advances and loans are only given for specific reasons and for limited amounts. Employers might also require employees to work with the company for a minimum amount of time to be eligible for an advance or a loan. These types of requirements are generally legal if they are applied equally to all employees.
- There could be tax consequences. If the advance or loan is not executed properly or not repaid, your employer might be liable for additional tax.
- There are additional paperwork and record keeping responsibilities. The extra administrative burden could be onerous for smaller employers.
Hopefully, your employer already has a documented loan policy in place. Reviewing this policy will make it easier when the time comes to speak with your employer. Check your employee handbook before approaching your employer for help.
Getting Professional Advice
If you’re experiencing a financial emergency, paying someone for advice might not be at the top of your list. But depending on the nature of your crisis and the amount of money you need, discussing your specific situation with a professional such as lawyer or an accountant might be worth it.
Also, companies that administer employer 401(k) plans sometimes offer access to a financial planner for free, so it’s worth determining whether this is an option.
Dealing with debt is tricky. While borrowing money from your employer could be the solution, consider your options carefully before heading down this path.
