In the digital era, employers are expected to turn to technology to simplify their business practices. One such practice is paying their employees. While some businesses still choose to issue paper paychecks, many have moved to a more modern way of paying employees – direct deposit. Research from the American Payroll Association found that 94% of U.S. workers receive their pay by direct deposit.
Once set up, direct deposit is a quick, simplified way to transfer money from your organization to your employees' bank accounts. Although it may sound complicated, setting up direct deposit is simple once you have the correct information from your employees.
How does direct deposit work?
A direct deposit, or an electronic funds transfer (EFT), is when money is deposited into a bank account electronically, rather than with a paper check.
"'Electronically' means through the ACH (Automated Clearing House) network – from the business's bank account to the individual employee's account," Ron Ross, co-founder and COO of payroll and payments platform Everee, told business.com. "Given the COVID-19 pandemic and more people working remotely, having all payroll go via direct deposit/ACH is the new normal."
Although direct deposit is an increasingly common way of paying employees, a few federal and state laws govern who is eligible to offer direct deposit and how. For example, if an employer wants to offer direct deposit to their employees, the Electronic Fund Transfer Act federally requires them to give each employee a summary of their rights and liabilities regarding direct deposit payroll payments.
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What do employees need to provide for you to set up direct deposit?
Before you can set up direct deposit for an employee, you need to gather a few things from them. You may have the employee bring you a voided check (a personal check with the word "VOID" written across the front), fill out a direct deposit form, or possibly even complete an online form.
You will need this information from an employee to set up direct deposit for them:
- The name and address of the employee's bank
- The account type (e.g., checking or savings account)
- The bank's routing number (also known as an ABA number)
- The employee's account number
- The name of the account holder (usually the employee, or the employee and their spouse for joint accounts)
If your business is offering direct deposit for the first time, you need to collect this information from every employee who wants payment via direct deposit. Moving forward, Ross said, businesses typically collect this employee information during new-hire onboarding.
Most of this information is right there on the employee's personal check or bank statement. Employees can often find this information in their mobile banking app as well. If they don't have access to any of these options, they can contact their bank for the information.
How to set up direct deposit for employees, step by step
Direct deposit service is relatively simple to set up, although it can take a few weeks between the start of the process and the day your employees get their first direct deposits.
1. Choose a direct deposit provider.
Before you can send out electronic payments to your employees, you will need the right system in place to process and transfer the ACH payments. There are various financial vendors you can turn to for this service; for example, if you already use a bookkeeping or online payroll service, it likely offers this payment option. [Need a payroll provider? Read about the best online payroll services of 2021.]
2. Review federal and state laws.
Again, there are federal and state laws for direct deposit payments, so it's important to familiarize yourself with the current laws that regulate businesses in your area. For example, many states require you to give each employee direct deposit disclosures and have them complete a direct deposit authorization form, which serves as employee consent and acknowledgment.
"The direct deposit form also gives the company authorization to deposit the employee's pay into their bank account electronically," Ross said.
3. Obtain employee information.
Have each employee provide the banking information outlined above. This is sensitive information, of course, so you must keep it secure. If they will be providing the information online, make sure you are using a secure website for it. You may also need to get a voided check or deposit ticket from each employee to verify their routing and account numbers.
If an employee doesn't want their paycheck deposited into a bank account, you may also offer the option to have it automatically loaded onto a payroll card (similar to a prepaid debit card).
4. Enter the employee information into your payroll system.
After you've collected your employees' direct deposit information, you submit it to your payroll provider, who can then process employee payments via ACH.
5. Run payroll and send payments via direct deposit.
The heavy lifting for your direct deposit setup is now complete. Once you've submitted all applicable employee and banking information, you may have to wait for it to be verified and processed. When all the information is confirmed, you can begin running payroll for your business. Payments will be automatically deposited into the employees' direct deposit accounts each pay period.
What are the benefits of direct deposit?
Direct deposit payments are beneficial to employers and employees, the primary benefits being convenience and security.
Benefits for employers
Setting up direct deposit is a relatively minor task that can result in major rewards. Instead of manually generating and distributing paper checks, you can rely on automatic payment processing that helps ensure timely employee payment. Direct deposit can reduce bookkeeping overhead, saving your business time and money on an otherwise-tedious task.
"Employers save on printing and mailing physical check copies when they opt for electronic deposits," said Nishank Khanna, CMO of Clarify Capital. "Depending on the number of employees within an organization, the overhead savings can be substantial."
In addition to saving time and money, direct deposit can increase your company's security. Paper paychecks run the risk of being stolen or lost.
"Fraud and theft are a major concern for small businesses," Khanna said. "When security is breached, it's an expensive problem to have. Electronic transactions are safer because personal information is stored within a secure network."
Benefits for employees
It's no secret that many employees favor direct deposit. Paper paychecks leave a lot to be desired – they can get lost, damaged, or stolen; they take longer to receive and access; and they can only be deposited into one account. Direct deposit remedies all these scenarios. Employees don't have to go into the office to pick up their checks, and they don't have to make a trip to the bank to deposit it. They have peace of mind that their paycheck will be quickly and securely deposited into their account, and they can access it as soon as they need it.
Additionally, when using direct deposit, an employee can have their check conveniently split up among multiple accounts. Overall, direct deposit simplifies employees' lives and can improve morale.