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7 Min. Read

How to Set Up Direct Deposit for Employees: A Complete Guide

How to Set Up Direct Deposit for Employees: A Complete Guide

Modern employers and small businesses need options when it comes to maintaining payroll processes and paying workers. Although paper checks are still an acceptable form of compensation, digital and electronic payment methods offer increased flexibility, convenience, and security. Data shows that up to 82% of American workers receive direct deposit, making it a choice worth pursuing.

The direct deposit process is one way to deliver payment quickly and efficiently. In this guide, we'll take a detailed look at how direct deposit payments work, the steps required for setup, and the benefits of using payroll software for your business. 

Here’s What We’ll Cover:

What is Direct Deposit?

Behind the Scenes: How Direct Deposit Works

Steps for Direct Deposit Setup

Are There Any Downsides to Direct Deposit?

Employees vs. Contractors

Reminders and Takeaways

More Payroll Resources for Small Business Owners

What is Direct Deposit?

Direct deposit is a safe and reliable process that delivers funds electronically to specified bank accounts as opposed to using a physical check. This process depends on a stable and secure electronic network to move money from one party (typically an employer) to another.

Standard income is not the only application for direct deposit payments. You might be able to receive direct deposit funds if:

  • You have an expected tax refund and choose this method through the IRS filing process
  • You expect to receive investment funds or payouts from retirement accounts
  • You have incoming funds through programs such as Social Security

Benefits of Using Direct Deposit

There are many advantages to using direct deposit payroll, both for the employer and employee. 

  • It replaces manual processes. Having to perform compensation manually can be tedious and draining on staff resources. Preparing paper checks is also a time-consuming task, particularly for large companies. Direct deposit replaces manual options with a more hands-off system.

  • Direct deposit promotes employee choice. When staff or team members choose direct deposit, they can often add bank account details for both checking and savings accounts. This allows employees to take control of their financial health by automatically sending money to savings.

  • It saves money on preparation and postage. Printing physical checks and paying for letters and stamps can add up over time. Reduce postage and needless administrative costs with the use of direct deposit services.

  • It's eco-friendly. As more companies promote green initiatives, reducing the use of paper is an environmentally friendly choice. 

Behind the Scenes: How Direct Deposit Works

The process works by leveraging an electronic network called the automated clearing house (ACH). When banks use the term "ACH payment", they are referring to funds that transfer electronically through this network.

Successful transfers only happen when both the payer and payee have accurate bank routing and account information on file. 

Once a payment is issued through the ACH network, funds are deposited at midnight on the business day of the payout. The transferred funds automatically clear, which means that there should not be a hold on the money after it has been transferred.

Steps for Direct Deposit Setup

Establishing the foundation for payroll transactions is a shared responsibility between the payer and payee. The former has an obligation to initiate the framework, and the latter should provide accurate bank account information.

Follow the simple steps below to initiate the deposit setup process.

1. Choose a payroll service provider 

Direct deposit providers include any payroll service that offers this as a core function. As a business or organization, you must first establish the ability to perform direct deposit through your normal software. Alternatively, you can work directly with banks and financial institutions for setup and approval.

2. Establish a company payroll account

A specific business bank account is required to make direct deposits. This account must be one that is set up to make successful ACH transactions on a regular basis. Additionally, it's crucial that the available funds are present prior to completing a payroll cycle.

3. Send a direct deposit authorization form to employees

An authorization form is one that an employer sends directly to each employee, typically upon hire. At minimum, the form should request an individual's contact information, bank account number, and routing number. A voided check can also be attached to the authorization form.

Some authorization forms ask for a Social Security Number (SSN) for further identity verification.

4. Verify correct account information

Once an authorization form is received, the payroll or finance department must upload this data into the payroll service or software. At this stage, check for any significant errors, missing numbers, or incorrect account information. Failure to do so means that an employee does not get paid.

5. Run standard payroll process

After completing these steps, the direct deposit setup is ready to go. The last step is running the typical payroll process based on the payment schedule of a given employer. Whether this is weekly, bi-weekly, or monthly, the direct deposit system does not change.

Are There Any Downsides to Direct Deposit?

Although there are many perks to implementing direct deposit, there are a few negative aspects to consider.

  • Potential overdraft fees – Careful maintenance and upkeep of the payroll bank account is required to ensure that there are adequate funds for each payment. Overdraft fees are always the responsibility of the payer, not the payee.

  • No option to stop payment – Unlike physical paper checks, you can't place a stop on an electronic transfer once it's been initiated. If errors are made, they must be corrected after the deposit clears.

  • Employees must start over when changing banks – While this is a minor inconvenience for most, a new authorization form is required every time an employee wants to switch or update their account of choice.

  • Possible banking security risks – Although ACH is a secure method, collecting account and routing numbers is a sensitive process. It's important to handle this data safely and securely to avoid unauthorized access to account information.

Costs and Fees

Using direct deposit necessitates having a reliable payroll provider, and this service is generally an administrative investment. In addition to software and provider costs, ACH transfers may incur banking fees as a small percentage of the transfer. Although minor, these can range from a few cents to a couple of dollars per check, and businesses should be aware of these charges in order to maintain accurate books.

Employees vs. Contractors

Both employees and independent contractors are eligible for direct deposit. For contractors or freelancers, this may be a simple matter of preference. Regardless of employment status, the ACH network transfer that occurs for each payout is the same. 

The main difference is that contractors will not have a W-2 on file, so it's important to verify identity and contact information when making a payment. 

Reminders and Takeaways

Before you implement any type of payroll process, set aside time to evaluate payroll software options and learn how certain functionalities work. This onboarding process will allow your business to handle many different types of financial transactions with ease.

Direct deposit is simply one way to capitalize on the benefits of accounting software and to reduce the time and effort spent on manual processes. To activate direct deposit, follow the directions and setup process of a particular payroll provider. For added protection, always maintain a detailed set of financial statements to illustrate and document your company's payroll processes.

More Payroll Resources for Small Business Owners