- Employees may request a payroll advance in times of financial stress or life events.
- Offering employees a payday advance in times of financial stress can boost employee morale and reduce turnover.
- Avoid payroll advance problems with the tips in this guide.
- This article is for employers who want to know how to give employees payroll advances.
When employees have a financial emergency or can’t make ends meet, they have limited options for quick cash. Very few people turn to family; most seek out high-interest payday loans, credit cards or personal loans. According to Pew Charitable Trusts, 12 million Americans rely on payday loans. The average annual borrower asks for a total of $3,000 per year while paying over $500 in interest.
Employers have the opportunity to help employees avoid stressful financial emergencies by providing payroll advances. A payroll advance offers a discreet way to benefit your employee while keeping them productive. It can also discourage the employee from choosing a high-interest loan that puts them further into debt.
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What is a payroll advance?
A payroll advance is a financial agreement between an employer and an employee. The employee receives money from the employer in the form of a short-term loan. The loan is paid back to the employer using future earned wages. The terms of the agreement can vary but should be known and agreed upon by the employer and employee.
Tip: To properly provide a payroll advance, you should first have a good handle on how payroll works in general. Having that baseline knowledge will help you formulate a policy for if and when you provide payroll advances.
How does a payroll advance work?
A payroll advance always begins with an employee submitting a written request. Having each payroll advance request in writing forms a paper trail and can also be helpful if there are any issues with the employee (refusal to pay it back, termination, etc.).
Once an employee submits the written request to be processed through payroll, both parties (employer and employee) must sign the agreement. The written request should include a payment plan so you can receive your money back on time.
If you are using the best payroll software, you can quickly process a payroll advance separately. However, if you are manually completing payroll, you will need to process a separate check or electronic deposit. You will also need to note the extra payment in your payroll register so your books reflect the payroll advance.
Employee loan vs. paycheck advance
An employee loan is a sum of money that the employee predetermines. The employer must approve the amount, and the employee uses future paychecks to pay back the loan in agreed-upon installments.
However, the employer is not guaranteed to get the loan money back. If the employee defaults on payments or frequently makes late payments, you will need to consider the consequences on your revenue streams.
A paycheck advance offers the employee pay they have earned, usually a couple of days before payday. A paycheck advance is less risky for the employer, as the employee has already acquired the money.
FYI: One way to avoid having to offer payroll advances is to offer on-demand payroll options. This allows your employees to get paid when they want to.
Pros and cons of offering paycheck advances to employees
Payroll advances have pros and cons for the employee and the employer. The main advantage for the employee is a reduction in financial stress. Removing this stress can help employees stay productive, take fewer sick days, and avoid seeking financial help from a payday loan company that charges up to 600% for quick cash. In addition, the employer can benefit from a more focused employee, resulting in higher revenues with little effort on the employer’s part.
However, payroll advances come with risks to the employer and employee. For example, an employer will see a rise in administrative paperwork and compliance with minimum wage requirements, overtime laws and the federal Truth in Lending Act. Plus, your business must be financially able to offer the employee the payroll advance, which may not be possible depending on your business’s cash flow and relationship with creditors.
Employees can also become dependent on payroll advances, leading to an “advanced paycheck to paycheck” lifestyle that isn’t healthy for the employee or the employer. Limiting how many payroll advances an employee can have per year helps keep this benefit in check and avoids confusion regarding payroll advance policies. In addition, payroll advance policies can outline situations in which payroll advances may be reduced or unavailable, such as an economic downturn, time off, or when workers’ compensation is involved.
Did you know? While employees may want a payroll advance paid via direct deposit, there are a number of direct deposit alternatives that you may want to consider using.
How to avoid problems with payroll advances
Before offering a payroll advance through your company, you need to have policies in place. The policy should include the following factors to reference when an issue arises.
1. Determine how the payroll advance process works.
There should be a clear and discreet way for an employee to request a payroll advance. For example, an employee could fill out a form, and if the advance is approved, the employer and employee sign the document. The form would include all the terms, including fees, interest, agreed payback time frame and any company-specific terms. If the employee does not hold up to their end of the payroll advance, they could face disciplinary action, termination or legal consequences.
2. Define who is eligible for the payroll advance.
Specifying eligibility helps you streamline who can receive a payroll advance and who can’t. Eligibility guidelines are especially helpful if your funds are limited, or a particular segment of your workforce has burned you in the past. For example, you could offer payroll advances to full-time employees but not part-time, or specify that the employee must complete a particular work period with your company to show their commitment before you’ll consider them for a payroll advance.
3. Set loan minimums and maximums.
Place a cap on the dollar amount of payroll advance each employee can receive within your policy. Caps will help you get your money back and help the employee be financially responsible.
4. Keep all terms in writing.
Include all aspects of payroll advances in written policies. Ideally, the same policy should be used with every employee and include all terms. The employee should be aware of these terms, and the employer and employee should agree on deduction amounts and when the deductions will start and end. Both parties should sign the agreement, with a copy placed in the employee’s file.
Tip: You should not tax the payroll advance until your employee has made their first repayment. Then, calculate the amount of repayment into the payroll for future pay periods.
5. Integrate the payroll deduction with your payroll software.
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6. Set the payroll advance frequency.
Failure to add the frequency of payroll advances out of your policy could confuse employees and even result in legal action. Most companies limit their employees to a payroll advance once every six months or twice a year.
Key takeaway: Add a clause that prevents employees from receiving a payroll advance if they haven’t paid back a previous one. Too much leniency on this policy could result in a significant loss of cash flow for your business.
7. Offer financial education.
After writing a payroll advance policy, consider providing employees with additional resources. For example, when an employee asks for a payroll advance, you could offer the option for financial counseling or provide them with free online financial courses to help them improve their situation in the long term.