Glossary of Human Resources Management and Employee Benefit Terms
Direct deposit is an option where funds are electronically transferred from one bank account to another. It is typically used for regularly scheduled payments, such as salary, pension, or government benefits. Money is exchanged from the payer to payee in a smooth, secure, and convenient process. That, combined with the fact that it is often quicker than a paper check, makes direct deposit appealing to many people.
Using direct deposit for payments has advantages for employers as well as employees. Businesses can save on resources needed for payroll and don’t have to worry about check fraud. Direct deposit also decreases the risk of lost payments and identity theft from stolen paper checks and paper billing statements. Additionally, because it reduces the amount of paper used to write checks or store financial transaction records, direct deposit is beneficial for the environment as well.
The biggest benefit for employees is how direct deposit makes getting paid quick and seamless. They do not have to go pick up a check, take it to their bank to deposit, and then possibly wait a day or two for the funds to clear. For employees, direct deposit really is “set and forget it.”
Automated Clearing House (ACH) is an electronic network that lets banks bundle and process multiple transactions together into batches. This technology makes direct deposit possible. It works when both parties have a bank account. However, those without a bank account can sometimes use a prepaid debit card, also called a payroll card.
Using the example of a paycheck, direct deposit is set up with the employee providing their checking or savings account information to their employer. A voided check or deposit slip is often used. The employer then instructs their bank to transfer money into the employee’s account on a certain day. This order is bundled with all the other ACH transactions for that day and scheduled. When the payment goes through, the employee’s bank credits the funds to their account, and the employer’s bank debits their account for the same amount. No paper check is issued, although an employee may still receive a payment stub or other payment documentation from their employer.
To receive payments by direct deposit, a direct deposit form must be filled out and submitted. This form requests the following information:
Bank or credit union name
Account type (checking or savings)
The bank’s routing number
In many cases, employees may also be asked to provide a voided check in order to verify the account and routing numbers. Those who don’t use paper checks may have to get a document from their bank that confirms the bank’s routing number and the employee’s account number.
The majority of U.S. workers (82 percent) are paid by direct deposit via ACH, so one doesn’t have to look far for examples of where it’s used. Whenever someone receives recurring payments directly into their bank account from an employer, pension, government benefit, tax refund, or investment payment, that is direct deposit. It is becoming more common for some businesses to require all employees to receive their paycheck by direct deposit.
The initial direct deposit setup can take one to two pay cycles in some cases. Once it is set up properly, the time it takes for funds to be transferred and available on the scheduled payday depends on factors like the type of payroll software being used and when payroll is submitted.
While a paycheck may not be deposited first thing in the morning on payday, direct deposit is much faster than paper checks for both the payer and payee. Employers don’t need to worry about printing checks, stuffing envelopes, and mailing or handing them out. That saves the employer time. Likewise, employees don’t have to pick up their check, deposit it at the bank, or wait for the paycheck to then clear and for funds to be available.