Many people experience financial hardships at some point in their lives. When it happens to employees, they might look to their employers for support. One available option is a payroll advance. It can help workers get through a difficult time, improving engagement and retention in the process, but it also poses administrative burdens and compliance risks. Employers may want to weigh the pros and cons of payroll advances before offering them or explore other ways to improve employee financial wellness.
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What is a payroll advance?
A payroll advance, or paycheck advance, is a short-term loan given by an employer to an employee to help them cover the cost of unforeseen expenses in between pay periods. For example, an employee who cannot pay a hospital or car repair bill before the next payday might ask for a payroll advance. This practice is common with workers who are living paycheck to paycheck, though it’s usually not a long-term solution to their financial problems.
How do paycheck advances work?
Employees and employers generally must agree to advances on paychecks in writing. The employer then lends the agreed-upon funds, which the employee pays back via subsequent payroll deductions. Employers may charge interest to cover any additional administrative fees incurred as part of the agreement, but they generally are not permitted to make money on the loan. All federal and state employment laws governing payroll advances should be consulted for more specific guidelines.
Pros and cons of payroll advances
An advance on a paycheck might seem like a reasonable request in some circumstances, but the risk is not always worth the reward.
Pros
- Improved productivity – Freed from worrying about how they will cover an emergency expense, employees may be more efficient at work.
- Higher engagement – Alleviating financial burdens allows employees to focus on what they love about their work, rather than simply making ends meet.
- Increased retention – Employees tend to be more loyal to employers who show they care about the financial well-being of their people.
Cons
- Administrative burdens – Offering an employee a paycheck in advance could make payroll processing more time-consuming and complex.
- Financial loss – If an employee quits or is terminated before the advance is repaid, the employer may have trouble recouping their money.
- Cash flow problems – Paying employees outside the regularly scheduled payday could make it difficult to cover other business expenses.
- Advance dependency – Wage advances mean employees have less money in their next paycheck, which could prolong their financial woes.
How to offer employees a payroll advance
As much as an employer might want to help employees in financial need, offering a payroll advance on a whim isn’t good practice. It’s usually better to prepare for such requests and create an official policy that addresses the following:
- Processes
Outline how employees can request salary advances and the disciplinary actions for policy violations. - Eligibility
Determine which employees will be eligible for advances, e.g., only full-time workers. - Minimum and maximum employee advances
Establish an acceptable range of payroll advancements to set employee expectations and help prevent cash flow problems. - Frequency
Limit the number of payroll advances that may be approved for each employee, e.g., two per year or once every six months. - Record-keeping requirements
Document the details of every payroll advancement, including the amount advanced, the length of repayment and any interest or fees charged.
What are alternatives to payroll advances?
Instead of offering payroll advances to employees, employers might consider earned wage access. It gives employees access to a portion of the wages they’ve already earned prior to payday. As a result, they can better address their financial needs in between pay periods without incurring loans.
Some earned wage access services, like Wisely® by ADP powered by DailyPay, can process transactions without disrupting an employer’s regular payroll operations. Employees appreciate the service, too, because it has no-fee withdrawal options that allow them to access their pay early at no additional cost. Wisely also offers financial wellness tools that can help employees track their spending, save for the future and make smarter decisions with their money.
Frequently asked questions about payroll advances
How are payroll advances different from payday loans?
Payroll advances are short-term loans financed by an employer and repaid by an employee via future payroll deductions. Federal and state regulations restrict how much interest employers may charge.
Payday loans are issued by third-party lenders. They are known for high interest rates and short repayment schedules that often lead to deeper debt. Some states consider payday loans to be predatory lending and prohibit it.
How are payroll advances different from employee loans?
The primary differences between payroll advances and employee loans are the amount financed and the repayment length. Advances are usually consistent with an employee’s regular pay and are repaid within a few pay periods. Employee loans, on the other hand, tend to involve large sums of money, which the employee repays over a longer duration.
Why do employees ask for paycheck advances?
Employees commonly ask for a paycheck advance because of an urgent, unforeseen expense that they cannot afford to pay before their next payday. Examples include medical bills and car and home repairs.
What's the downside of a payroll advance?
Without limitations, employees can become dependent on payroll advances and spiral further into debt. The practice can also be risky for employers, who may experience administrative burdens and cash flow problems. They can also lose money if the employee leaves the organization before the credit is repaid.
Is a payroll advance taxed?
A payroll advance is not taxed when it is loaned to the employee. However, the repayments to the employer are withheld after all statutory deductions, which means the required taxes are still paid on the income.
This article is intended to be used as a starting point in analyzing payroll advances and is not a comprehensive resource of requirements. It offers practical information concerning the subject matter and is provided with the understanding that ADP is not rendering legal or tax advice or other professional services.
