What is Direct Deposit?
Direct deposit involves the electronic transfer of funds from the employer to the bank accounts of its employees, using the Automated Clearing House (ACH) system. This is an efficient and low-cost payment method. The payment process is to calculate pay in the same manner as for check payments, but to then send the payment information to a direct deposit processing service, which initiates electronic payments to the bank accounts of those employees being paid in this manner.
The processing service deducts the funds from a company bank account in advance of the direct deposits, so cash flow tends to be somewhat more accelerated than is the case if a company were to issue checks and then wait several days for the amounts on the checks to be withdrawn from its bank account.
ACH is an electronic network for the processing of both debit and credit transactions within the United States and Canada. ACH payments include direct deposit payroll, social security payments, tax refunds, and the direct payment of business-to-business and consumer bills. Within the ACH system, the originator is the entity that originates transactions, and the receiver is the entity that has authorized an originator to initiate a debit or credit entry to a transaction account. The transactions pass through sending and receiving banks that are authorized to use the ACH system.
The Advantages of Direct Deposit
Direct deposit is more efficient than payments by check, because it does not require a signature on each payment, there are no checks to be delivered, and employees do not have to waste time depositing them at a bank. Further, employees who are off-sight can still rely upon having cash paid into their accounts in a timely manner. Finally, all of the controls used to monitor checks are eliminated.
Direct deposit can also be more efficient from the perspective of the remittance advice. A number of payroll suppliers offer an option to simply notify employees by e-mail when their pay has been sent to them, after which employees can access a secure website to view their remittance advice information. This approach is better than sending a paper version of a remittance advice, because employees can also access many years of historical pay information on-line, as well as their W-2 forms.
Problems with Direct Deposit
Despite its efficiency advantages, direct deposit is not perfect, for it requires employees to have bank accounts. If this is an issue, consider using a blended solution with pay cards for those employees who do not have a bank account. Also, banks charge a fee for direct deposit payments, though the net cost of this fee is less than the cost of check stock, mailing costs, and check processing fees if you were to instead pay employees by check.
The implementation of direct deposit can cause some initial difficulties, because you must correctly set up each person’s bank account information in the direct deposit module of your payroll software (or software provided by your outsourced payroll supplier). This initial setup is remarkably prone to error, and also usually requires a test transaction (the pre-notification) that delays implementation by one pay period. Consequently, even if a new employee signs up for direct deposit immediately, you must still print a paycheck for that person’s first payroll, after which direct deposit can be used.
A final issue with direct deposit is being able to do so from an in-house payroll processing function. If the payroll software does not provide for direct deposit, then you will have to contract with a third party to make the payments on behalf of the company. Direct deposit is much easier to implement if you are outsourcing payroll, since direct deposit is part of the standard feature set for all payroll suppliers.