How to Set Up Direct Deposit

What is direct deposit?

Direct deposit is the electronic transfer of money from one bank account to another without paper checks or cash. In a small business context, direct deposit means electronically delivering employees their wages (with payroll taxes deducted when applicable). If you forgo paper checks and your employees log in to their bank accounts on payday for proof of payment, you’re paying by direct deposit.

Aside from wages, people also receive other income through direct deposit, including child support, Social Security benefits and tax refunds. However, in this article, we’ll discuss direct deposit as a method of paying employee wages.

How does direct deposit work?

Direct deposit is a form of ACH payment. The abbreviation “ACH” signifies “automated clearinghouse,” which indicates that your deposit has gone through the American financial system. The organization National Automated Clearing House Association (Nacha) oversees this process.

The “clearing” that takes place in the “house” is the approval of your deposits. If you don’t have enough funds in your account when your bank sends all your direct deposits to the ACH, your deposits won’t go through. Assuming you have enough funds, each employee’s bank will receive your deposit, credit the employee’s account accordingly and debit yours. The process typically takes one to two business days.

What are the benefits of direct deposit?

Approximately 93% of U.S. employees receive their paychecks through direct deposit. That’s primarily because direct deposit is tremendously beneficial for both small business owners and employees. Below, we’ll explain some key direct deposit benefits for both groups.

Direct deposit benefits for small businesses owners

Small business owners often prefer direct deposit to paper checks or cash for these reasons:

• It’s more affordable. Cutting checks can get costly. You have to buy special paycheck paper and printer ink constantly, and that’s after the often substantial spend on a laser or inkjet office printer. Additional postal costs come into play if you mail checks rather than hand them out in person. Direct deposit has none of these expenses and can be up to $3 cheaper per paycheck. Spread across your whole team, that can add up to huge savings.
• It’s faster. Each of the costly paper-check printing and mailing steps is also tedious and time-consuming. Direct deposit, on the other hand, is a fully automated process. Yes, in some cases, you’ll initially need a few minutes to collect and enter your employees’ information. Still, direct deposit is a much shorter process than printing and mailing checks – and often, employees, not you, add their info.
• It’s more secure. In 2020, stories abounded about “mailbox fishing” – namely, fraudsters stealing checks from mailboxes and altering their amounts and recipients. Direct deposit eliminates the possibility of this increasingly common form of fraud. Plus, assuming your payroll service and bank implement thorough cybersecurity measures, all direct deposit data will be encrypted.
• It reduces your carbon footprint. It’s common knowledge that paper use is bad for the environment. Less commonly discussed is the amount of carbon emissions involved in postal mail. When you opt for direct deposit, your business plays no part in this environmental damage. Most small businesses massively cut down on nonrenewable resource use when switching to direct deposit.

Direct deposit benefits for employees

Employees often prefer paperless payroll options to physical checks for these reasons:

• It eliminates bank trips. Employees who receive paper checks must bring them to their bank for deposit. This errand further delays when an employee’s wages become available. Sure, you could argue that this issue no longer exists since 12 million people have ditched in-person bank runs for mobile check deposits. However, mobile deposits still require a few minutes on your mobile app. Direct deposit eliminates that time, too.
• It creates predictability and stability. Under direct deposit, employees know exactly when their wages will be available. Contrast this with paper checks, which put the burden on the employee to find time for mobile deposits or bank trips. Direct deposit is clearly the winner for helping your employees achieve predictable, stable finances.
• It allows for split deposit. Your employees can’t deposit paper checks into two bank accounts. Instead, they’ll have to deposit their checks into one account and then transfer money to another account later. Direct deposit, on the other hand, enables split deposit. If an employee wants to route 70% of their wages to their checking account and 30% to a savings account, that’s entirely possible.
• It organizes pay stubs. An employee’s paper pay stubs can easily get disorganized in a file cabinet. When you enable direct deposit, your employees receive electronic pay stubs stored chronologically in your payroll software. This way, employees can easily access their wage and deduction details with just a few clicks.

How to set up direct deposit for your business

Typically, it’s easy to set up direct deposit for employees. Here’s how to do it.

1. Choose a payroll service.

For most small businesses, the best option for direct deposit is a payroll service. That’s because payroll services calculate the amount you must pay employees per pay period, so they’re in the best position to execute those payments. Although you can set up direct deposit through your bank, choosing the right payroll service offers your business additional features and functionality that greatly benefit its everyday operations.

Payroll services are often affordable enough for any small business owner to use. For example, OnPay’s pricing structure is geared toward very small businesses, and direct deposit ranks among its key features. (Read our OnPay review for more information.)  

Likewise, ADP can enable direct deposit for even the most complex payrolls. (Read our ADP review for more information.)

2. Formally register for direct deposit.

Most payroll services will allow you to register for direct deposit in just a few minutes. You’ll typically add your bank account information and respond to a verification email confirming that you’re the one running direct deposit. You’ll then run a test deposit in which small withdrawals are taken from the account, and you record their amounts. If your payroll service tells you that you’ve recorded the right amounts, then your direct deposit setup is complete.

3. Obtain your employees’ bank account information.

To deposit wages directly into your employees’ bank accounts, you’ll need each employee’s bank account number, routing number and bank name. You’ll also need to know whether you’re depositing to a checking or savings account. You can either seek this information from your employees or have them add it to your payroll software themselves if your payroll service allows.

In addition to employee banking information, you’ll need to obtain authorization. To do so, have your employees complete and sign an authorization form. You can usually customize these forms to your business, but no matter how they appear, they should permit you to pay wages electronically.

4. Input your employees’ banking information.

If your employees didn’t add their information directly to your payroll software, now’s the time to do so. Note that if you’ve gone the bank route instead of using payroll services, you should start by compiling all your employees’ information in your accounting software. You can then export it all to a single Nacha file to send to your bank. Alternatively, just as with payroll software, manual addition is possible.

5. Establish your pay schedule.

Determine whether you’ll pay your employees weekly, biweekly, bimonthly or monthly. If you’re switching from paper checks to direct deposit, make the change with enough time to get direct deposit running by your next pay date. The process typically takes seven to 10 business days to finalize. You should also confirm with your payroll service that your direct deposit services won’t interrupt or alter your typical pay schedule.

At the same time, you should update the deadlines for receiving your team’s pay cards or other time and attendance records. Upon receiving these records, you should review them and file them with your payroll service. The key here is that payroll services typically need to receive this information a certain number of days before running direct deposit. Set your deadlines based on this timeline.

6. Run payroll as usual.

After you’ve taken the above steps, your payroll and direct deposit should be entirely automated. Your employees should now receive their wages electronically every payday. If anything goes wrong, you can always contact your payroll service for help; their customer service department is meant to handle this. But if you’ve chosen your payroll service well and followed all the above steps, everything should go just fine.