Nearly two-thirds of consumers report living from paycheck to paycheck.1 While definitions vary, generally that means people spend most of their earnings on necessities like rent, food, and utilities, with limited or no money remaining for extras, savings, or emergencies.
That leads more than 12 million people every year to take out payday loans in the 26 states where payday lending is allowed, according to a Consumer Financial Protection Bureau press release.2 The average annual percentage rate (APR) of those loans: 391%.
Instead of turning to payday loans, employees may ask their employers: “Can I get an advance on my paycheck?”
Business owners in jurisdictions that allow this who run payroll can consider offering their employees payroll advances to help them manage financial emergencies and other unexpected situations. This can be a valuable tool to help alleviate stress and foster loyalty.
Before you consider offering this benefit to your employees, read on for some key things to understand.
What is a Payroll Advance?
A payroll advance, sometimes called a salary advance or employee cash advance, is a short-term loan an employer extends to an employee. This involves providing the employee with money before their regular payday.
Unlike a payday loan, a payroll advance is typically repaid through deductions from future paychecks, which can help minimize the financial burden on the employee. This can be beneficial for employees who need access to funds without incurring the high interest rates associated with payday loans.
How Does a Payroll Advance Work?
When an employer decides to provide an employee with a payroll advance, they should agree on the terms in writing. Those terms can include, but may not be limited to, the amount of the advance and the repayment schedule. From there, the employer would provide the employee with the money and deduct a set repayment amount from future paychecks.
It’s important to emphasize that an advance on a paycheck from the employer will be deducted from future paychecks, reducing the amount the employee will receive on future paydays. Deductions from future paychecks is a way for the employee to repay the loan from the employer. Clear communication about pay advance meaning and repayment terms is critical to help employees understand this.
In most cases, employers are not allowed to charge interest with an employee advance. In some cases, employers may be allowed to include an administrative fee. It’s wise for the employer to consult with a finance or legal professional for specific guidance on any federal, state, or local employment laws that cover payroll advances.
Is a Payroll Advance the Same as a Payday Loan?
No. A payroll advance is different from a payday loan. While both can offer short-term financial relief, payday loans usually originate from third-party lenders. These lenders tend to charge high interest rates that can often escalate debt. However, a payroll advance is an employer-provided benefit. This can make a payroll advance a more affordable option for employees.
Should I Give My Employee an Advance on Their Paycheck?
The decision to offer your employees the option for an advance on their paycheck depends on many factors. Some things to consider include whether your jurisdiction allows the practice, your comfort level, your company’s financial situation, and your ability to manage the administrative tasks associated with advancing the pay and monitoring the repayment.
Offering a payroll advance can be a lifeline for employees in need, helping them to manage sudden financial pressures or emergencies.
Pros and Cons of Payroll Advances
Here are some pros and cons to help you make a decision that aligns with your business goals and employee needs.
Pros of Offering Payroll Advances
- Employee Well-Being. Providing financial assistance when employees need it most can help improve employee morale and well-being.
- Increased Productivity. Employees who are less stressed about financial issues may be able to focus more on their work. This can lead to increased loyalty and productivity.
- Employee Retention. Offering payroll advances can be a valuable retention tool. It can demonstrate you care about your employees and their financial stability. This can help retain employees and reduce turnover.
- Attractive Perk. In a competitive job market, unique benefits like payroll advances can differentiate your business and give you an edge over other employers.
Cons of Offering Payroll Advances
- Cash Flow Impact. Providing payroll advances can affect your business’s cash flow. Small businesses with limited financial resources need to consider this. Before offering a payroll advance, make sure to carefully assess your company’s financial capacity to offer them in the future.
- Administrative Burden. Managing payroll advances can add complexity to your payroll process. It can require more time and resources to process the advance and manage the deductions for repayment. An automated payroll solution that supports post-tax deductions to repay cash advances or loans can help simplify this for employers.
- Potential for Overuse. Employees may overuse payroll advances with repeated requests which could lead to financial dependency. Establishing clear policies and monitoring usage patterns can help manage this.
- Legal Considerations. You will need to make sure you follow applicable federal, state, and local laws regarding payroll advances, including disclosing terms and creating formal repayment schedules. Different jurisdictions may have specific regulations regarding payroll advances. You will also need to understand how advances might affect payroll taxes.
Setting Up a Payroll Advance Program
If you decide to offer payroll advances, it’s crucial to establish a clear policy and process. A well-structured program can help create transparency and fairness. It can also help minimize potential misunderstandings and conflicts. Here are some things to consider.
Legal Considerations
Consult with a legal, employment law or financial professionals for assistance in setting up a program that follows relevant laws and regulations. Some jurisdictions have specific requirements for payroll advances.
Identify and Establish Clear Policies
Create a written policy to outline eligibility criteria, advance limits, repayment terms, and any fees that may be associated with a payroll advance. The document, which could be included in your employee handbook, can serve as a reference for you and your employees. This written policy can help employees understand the rules and conditions associated with a payroll advance. If you decide offering a payroll advance isn’t right for your business, consider including that in your employee handbook.
Determine Eligibility Criteria
Define who qualifies for payroll advance. You might want to consider factors such as employment duration, financial need, or past advance requests. Identifying the criteria from the start can help prevent overuse. It can also provide a framework that can help create a more objective process.
Set Advance Limits
Determine the maximum amount employees can request as a payroll advance. This limit could be a percentage of their expected earnings to make it easier for them to repay the advance. Setting limits can also help minimize your company’s financial exposure. You’ll also want to consider how your program answers the question “How many paycheck advances can I get?”
Establish Repayment Terms
Decide on a repayment structure, including the deduction from future paychecks and the repayment period. While the particular terms may depend on the requirements in your jurisdiction, you can typically work to make the terms reasonable to avoid additional financial strain on the employee. Terms should be clear to help avoid any misunderstandings. It is good practice for you and the employee to sign an agreement clearly stating all the terms.
Communicate the Policy
Communicate the payroll advance policy to all eligible employees. This can help set expectations while reinforcing your commitment to supporting employees.
Best Practices for Managing Payroll Advances
Documentation and Recordkeeping
Maintain accurate records of all payroll advances, including agreements, repayment schedules and deductions. Proper documentation can help prevent misunderstandings and disputes. It can also provide insight into the program’s usage and effectiveness.
What are Alternatives to Payroll Advances?
If offering a payroll advance option to your employees isn’t feasible for your business, here are other benefits you can consider that could help.
- Consider Flexible Work Arrangements. A flexible work schedule could allow employees to adjust their schedules to take on additional work and earn more income.
- Review Pay Frequency. If possible, consider increasing pay frequency so employees get paid more often. More frequent checks could offer some relief. For example, moving from a monthly or semimonthly pay period to a biweekly to weekly one could provide employees with access to their wages sooner.
- Offer Access to Financial Wellness Programs. When employees face financial stress, it can impact their productivity. Offering financial wellness programs such as budgeting workshops or access to professional debt management advice can alleviate this pressure so they can focus on their future.
- Introduce an Employee Assistance Program (EAP). For many, EAPs can serve as a lifeline during critical times. The programs can help address issues ranging from mental health and substance abuse to financial and legal advice, depending on the service selected.
Conclusion
A payroll advance can be a powerful tool to support employees in financial need. Understanding the pros, cons and best practices can help you decide if a payroll advance program is right for your business and your employees.
Simplify Payroll and Payroll Tax Management
You’re an expert in your field. You don’t need to be one in payroll and payroll tax management. The right payroll service provider can help you focus on your business, customers, and employees.
Have questions? Connect to see how SurePayroll can help you simplify your success.
1 Press release on the PR Newswire from the LendingClub.
2 Consumer Financial Protection Bureau.
