Your Guide to How Direct Deposit Works

When was the last time you waited in line to cash a paycheck? American workers have spoken, and the preferred way to be paid is through direct deposit. Let’s dive into how Direct Deposit works, its alternatives, and the federal and local compliance considerations you’ll need to make as an employer.

How Direct Deposit Works

Direct deposit is an electronic form of payment that allows employees’ wages to be automatically deposited straight into the checking or savings account of their choosing. Behind the scenes, a complex network called Automated Clearing House (ACH) makes it all possible. Last year, nearly 25 billion transactions were processed through ACH, moving around over $43 trillion in total. There are a lot of moving parts involved in the process, but here’s a stripped-down overview of how ACH works:

1. An employer submits employee payment information to its financial institution, which then subsequently batches it with other payments for processing at regular intervals throughout the day.
    

2. The batch is transmitted by the bank and received by an ACH Operator, which serves as an intermediary and validates and sorts the payments.
    

3. The sorted payments are sent to their destination bank, who then makes the funds available to the respective individuals on payday.

While that seems straightforward, a lot can go wrong without the direction of a seasoned finance team or payroll provider. You can learn how to spot and remedy these errors by reading our guide here.
 

Also note that direct deposit isn’t a free service. Initial setup fees for employers can range from $50 to $150, depending on the size of your company and the bank it uses. Employers are also charged for every direct deposit transaction—on average, about $1.50 per employee. If you’re in the process of evaluating payroll providers, be sure to ask whether they take on these fees for you (which is becoming the industry standard).

The Competition: Paycards

Direct deposit has emerged as the country’s most popular payment method. A report from the American Payroll Association found that more than 93% of employees opted to receive wages straight into their bank account through direct deposit. Employers are fans too, as paycheck printing can be an expensive proposition. Boston University found that its recent push to move away from traditional checks saved it nearly $50,000 per year, not to mention over 3,000 pounds of paper.
 

Even though direct deposit remains the most common way to pay employees, it faces growing competition from a scrappy up-and-comer: paycards. These physical, plastic cards work a lot like regular debit cards. On payday, funds are transferred onto the cards and employees can either use them to make transactions directly, or withdraw cash from them at an ATM. 
 

So is direct deposit’s moment in the sun finally over? Likely not, in part due to the number of very public controversies surrounding paycards. Due to the hidden fees some providers charge for withdrawals and paper statements, employees could spend up to $50 a month just to access their earnings. While paycard vendors have lowered their fees in response to a high profile New York Times exposé, that hasn’t stopped some lawmakers from labeling paycards as a form of “wage theft” and in-turn passing legislation regulating their use.

Consider State and Local Compliance

Direct deposit, with all of its advantages over paper checks and paycards, might seem like the most logical way to go. While that may be obvious to you, your company can’t necessarily make the call on workers’ behalf.
 

At the federal level, employers are allowed to require direct deposit adoption, as long as employees have the right to choose their own bank account. If you do require employees to use the same financial institution as your business (in an effort to save on direct deposit fees), only then must you offer alternative payment methods.
 

That’s the federal requirement, but many states and cities have laws going beyond this. In New York, for example, employers must offer cash or physical checks in addition to direct deposit. The same goes for California, and you’ll also need the employee’s written consent before enrolling them in direct deposit. Check with your state labor department to confirm the wage payment rules for your jurisdiction.
 

Here’s a rule of thumb that can help you navigate direct deposit laws, how direct deposit works, and HR compliance in general: when federal and local laws contradict, the provisions most generous to employees apply.

Employees love a payday. Getting paid on time, every time is anyone’s minimum expectation of an employer. But behind the scenes, there’s a lot that needs to happen in order for money to make its way from point A to B. Direct deposit doesn’t happen with the click of a button; it’s a jargon-laden process, involving “batch files” and intimidating acronyms like “ODFI.” Simply put, there’s a reason why payroll processing day isn’t something we look forward to in HR.
 

It doesn’t have to be that way. Namely processes over $7 billion in annual payroll, most of it via direct deposit. If you want to see how our technology and service can make you love payday again, schedule a call.