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Technologies such as payroll software have revolutionized payroll processing so it’s now as easy, efficient, and flexible as it’s ever been.

As such, many employers can now easily offer direct deposit to their employees as a payment method. Here I’ll take you through what that means, what the benefits are, and how to set up direct deposit.

What Is Direct Deposit?

Direct deposit is a payment method where employers electronically transfer employees' earnings directly into their bank accounts, rather than issuing paper checks or cash. This process is facilitated by the banking system and allows for a faster, safer, and more efficient means of distributing salaries and wages.

In the US, direct deposit is classified by banks as an ACH payment. ACH stands for Automated Clearing House, which is the network that oversees these types of transactions take place across.

How Does Direct Deposit Work?

  1. You (as an employer) process payroll and set up direct deposit orders with your bank.
  2. On payday, your bank will send direct deposit requests to the ACH where they are processed and passed on to employees’ financial institutions who will then credit their accounts with the amounts specified in the direct deposit orders.
  3. Simultaneously, an equal amount of funds are debited from your business account.
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What Are The Benefits Of Direct Deposit?

Direct deposit is another instance of automation making a process more efficient.

Benefits of direct deposit for employers

  • Increased efficiency: Processing payroll electronically through direct deposit streamlines the payment process by reducing the administrative burden associated with handling, printing, and distributing paper checks or money.
  • Reliability: Payroll processing via direct deposit is highly reliable and accurate.
  • Consistency: All funds will be debited on the same day, making cash flow more reliable. This is particularly important for small businesses.
  • Simplified record-keeping and reporting: Electronic transactions make it easier to maintain accurate and accessible financial records. Employers can easily track and report on payroll expenses, which is beneficial for accounting and tax purposes.
  • Flexibility in payroll management: Direct deposit allows for more flexible payroll arrangements such as on-demand pay.
  • Scalability: As a business grows, direct deposit makes it easier to scale payroll operations.
  • Improved security: Direct deposit minimizes the risks of check fraud, lost or stolen checks, theft, and forgery.
  • Employee satisfaction: Employees generally prefer direct deposit for its convenience and reliability, which can contribute to overall job satisfaction and loyalty.

Benefits of direct deposit for employees

  • Convenience: Direct deposit eliminates the need to physically go to the bank to deposit a paycheck. Employees don’t have to worry about bank hours or taking time out of their day to handle their paychecks.
  • Safety and security: There’s a lower risk of theft or loss compared to physical checks. 
  • Reliability: Employees can count on their paycheck being deposited on payday, regardless of whether they are at work that day.
  • Electronic records: Direct deposit provides employees with a clear electronic record of income, which can be helpful for budgeting and tax purposes.

How To Set Up Direct Deposit

The process to set up direct deposit is relatively simple.

  1. Choose a direct deposit provider: If you payroll process in this house this will be your chosen financial institution but you might decide to work with a payroll company that can handle direct deposit payment.
  2. Set up direct deposit: If you’re handling payroll in-house this means contacting your bank and signing their ACH T&Cs. If you use payroll software, simply follow the steps provided by the provider.
  3. Collect employee information: You will need to collect banking information from your employees, including their bank account numbers, bank account types, bank names, and the bank’s routing numbers. You'll also need authorization from each employee to deposit money into their account. This is typically done through a direct deposit authorization form.
  4. Enter employee information into the payroll system: Unless they can do it themselves, you’ll need to input each employee's banking and personal information into whichever system you’re using. For banks, it’s expedient to export a NACHA file from your accounting software and upload it through your bank’s online system.
  5. Run a test transaction: Before implementing direct deposit for all employees, it's wise to run a test transaction. This can help you ensure that everything is set up correctly and that the funds are being appropriately transferred.
  6. Sync deposits with your payroll schedule: Double check with your bank or payroll service to ensure that your payroll schedule is on track as some a certain number of days in advance of payday for direct deposit.
  7. Run payroll: Run payroll according to your determined schedule and opted-in employees will be happy to be paid by direct deposit.

Direct Deposit Cost

The amount it will cost your business to use direct deposit depends on a few different factors:

  • Your bank: If you use a bank, then there’ll likely be a setup fee and potentially an ongoing monthly fee.
  • Your payroll software: while most providers offer direct deposit as part of the package, some may charge extra.

Common Direct Deposit Errors

While direct deposit is highly efficient and accurate, it’s possible that errors can occur. Here are some common errors to be aware of:

  • Entering the wrong bank account or routing numbers for an employee is one of the most common direct deposit errors. Any changes must be promptly updated (this is something employee self-service can help with).
  • If an employee’s authorization form for direct deposit is not properly completed or processed, it could prevent the setup of their direct deposit.

Toward A Smooth, Efficient Payroll Process

Running payroll has been made much easier by technologies such as payroll software and online banking.

Check out our article on payroll processing for guidance on running a smooth, efficient payroll process.

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By Finn Bartram

Finn is an editor at People Managing People. He's passionate about growing organizations where people are empowered to continuously improve and genuinely enjoy coming to work. If not at his desk, you can find him playing sports or enjoying the great outdoors.