To Prepay or Not to Prepay? Pondering the Payroll Advance for Employees

August 2, 2018

Considering a payroll advance for an employee? Understand the good, the bad, and what to consider so it's a win-win for the employee and the company.

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You probably aren’t so far removed from your early 20s that you have forgotten the stressful moments when you logged into your bank account and realized you had more bills going out than you had funds coming in. There are few things more stressful than wondering how you’re going to make ends meet. Some people have no problem turning to family in such situations, or falling back on a credit card. For others, neither of those options may be possible, so as their employer, they might turn to you for assistance.

Properties of a Payroll Advance

A common way for employers to aid employees needing a little extra cash until the next payday are with payroll advances. Understanding payroll advances is key to determining whether or not providing them is a practical endeavor for your company.

A payroll advance is an unsecured loan provided by an employer, with the intent to recoup the funds on the employee’s next paycheck (and in some cases extended over an agreed-upon term). A payroll advance is not typically a loan with interest. Some employers charge a fee to cover administrative costs, which consequently might deter employees from asking for an advance.

Post It

After deciding whether or not a payroll advance is something your company can provide, the most important thing is making sure to post the payroll advance policy clearly for employees. In other words, you want to avoid any possible scenario where the employee perceives the advance as a freebee, petty cash, or “Sure, you can have your paycheck early, and then you can just pay us back (wink).”

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The payroll advance is in fact a loan, regardless of whether or not it includes interest. It’s a good idea to include the policy in the employee handbook, or under the employees tab on your website. If the policy is in clear terminology, it will ensure that employees at all levels within the company understand. With a little research, you can find templates that you can customize with your company’s policy.

It’s also necessary to thoroughly outline the employer’s plans for recouping the funds.  This is important should there be an unforeseen termination (initiated on either side) before the next paycheck date. A procedure for repayment after termination needs to include options for repayment, the method of repayment, and time frame.

Pay it Properly

If your company decides to allow payroll advances, it is key to pay the advance properly.  Your company needs to have the administrative bandwidth to record and process all advances. This allows accurate tracking of an employee’s earned wages, versus what he/she received as an advance.

If an employee requests an advance, don’t ask for too many details regarding the reason to avoid any perceived discrimination. You must give payroll advances equally to all employees, regardless of race, gender, or sexual orientation. The fewer details you have about the reason, the more objective you can remain when determining eligibility.

Related:  The Employer’s Guide to Fringe Benefits

Include the Advance with Payroll

Regarding amount, paying an advance isn’t just cutting a check for half the amount of the employee’s last check.

Lina F
Lina Freed,
Senior Payroll Specialist,
Journey Employer Solutions CO

Lina Freed, Senior Payroll Specialist for Journey Employer Solutions Colorado, clarifies why consulting with your payroll specialist for an advance is crucial for proper payment.  She explains,

Allowing advances to employees when they’re in a bind is always a kind gesture that employees appreciate. It is, however, important for employers to understand the risks involved with advancing the employee funds, especially if the amount is larger than the employee’s next check. Even if the employee is not terminated, they may be injured outside of work and unable to perform work duties, which could cause delays in recouping the funds. It is also extremely important to make certain payroll is involved with this process for many reasons. If the advance has already been paid out, payroll will make certain it’s accounted for on the employee’s next check. If you are advancing the employee’s check early, say before they leave on vacation, it’s best to notify payroll rather than assuming what you think the taxes might be. Guessing could make you liable for the tax difference.

Other Considerations

You will need to take into consideration whether or not an employee is hourly or salary. If an employee is hourly, they might have worked overtime hours that they didn’t work during the following pay period. Remember, an employee’s pay cannot dip below minimum wage, so consider taxes and any applicable fees before agreeing to a payroll advance.

This also needs consideration, should you decide to charge interest for any advance repayments covering extended terms. Additionally, charging interest can be sticky. Some state laws prohibit payroll advances as a profitable revenue stream for organizations not specifically designated to do so. However, they may permit charging a nominal fee or low interest to cover the administrative costs of processing.

Potential Pitfalls

A payroll advance could limit stress to your employee's livesIn order to avoid potential pitfalls when issuing a payroll advance, be mindful of the most common mistakes. The biggest consideration needs to be made regarding the Federal Truth in Lending Act (TILA), which governs fees, finance charges, and interest with regard to lending.

Be aware of your state’s consumer credit laws to prevent any additional legal issues when providing a payroll advance. Moreover, while you want to remain objective, it’s still important to consider the impact of a payroll advance on your employee’s next paycheck. What percentage of the next check will the advance be? Will this cause a recurring advance situation if the advance is too much of the next check?

This ties in with an employer desiring to avoid being labeled as a creditor, a status which occurs after someone has extended credit to consumers more than 25 times in the previous calendar year. If more than one employee develops a habit of requesting advances, it’s understandable how an employer can quickly become considered a creditor.

Related:  IRS Tax Scams Becoming More Finessed

The Promising Future of Payroll Advances

While policies and procedures vary, there are certain to be some changes in the future of payroll advances. Employers recognize the mental and emotional benefit of employees feeling secure in their finances.

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In 2017, Walmart divulged its new system for employees to access earned wages without going through a superior. This changed the mentality of the payroll advance for many of their employees. There is often a stigma associated with an associate needing to access his/her wages before they are issued. In fact, Walmart reportedly allowed as many as 1.4 million employees to take their wages early, by means of an app at their fingertips.

The policy does have its limits, as there is no fee to employees unless they exceed 8 advances in a calendar year. Despite the fee, this new app is a nod to the technological advances companies are making in all sectors of business—including those sectors which had previously required employees to feel vulnerable in their ask.

New processes such as this could lead to more payroll advances, or they could potentially allow employees to get on track to better manage their money and avoid high-interest charges or the expensive fees associated with traditional payday loans and credit cards.

Plainly Put

In summary, if your company is considering the ramifications of payroll advances, it’s good to fully understand the federal and state laws surrounding consumer lending.

Payroll advances can be a great alternative for employees who would otherwise spend a lot of money just to make it to their next paycheck. Payroll advances could also cost your company money, if not issued appropriately. Either way, it is likely that an employee will eventually approach you and inquire about a payroll advance. Now is a great time to consider your policy and get something in writing on the topic.

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