We’ve come a long way since paper paychecks. Thanks to direct deposit, employees no longer need to head straight to the bank on payday. Although direct deposit is a safer, cheaper, more environmentally friendly and more efficient way to pay employees, it experiences occasional problems. Because it’s essential to pay your employees accurately and on time, you must understand how direct deposit works and whether it suits your business. Fortunately, high-quality payroll services can help.
What is direct deposit?
Direct deposit is the electronic form of a paycheck. It’s an electronic transfer of funds from an employer’s business bank account to an employee’s bank or credit union account. It’s also known as an Automated Clearing House (ACH) transaction. This process requires the employee’s name, bank account number, routing number, type of account, bank name and address.
When you run payroll, employees who have elected to receive their pay via direct deposit will have their paychecks automatically deposited into their bank account. But direct deposit isn’t just for paying wages.
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“It is also used for tax refunds, retirement benefits, expense reimbursem*nts, investment distributions and insurance claim payments,” said Heather McElrath, a former spokesperson for Nacha (formerly called the National Automated Clearing House Association) and founder of Sandbox Communications.
How to set up direct deposit
A small business owner can set up direct deposit in five basic steps. Ultimately, the process will run through a payroll provider or bank, which brings us to the first step.
1. Choose a direct deposit payroll provider.
When you’re choosing the right payroll provider for your needs, pay close attention to the services offered, the fees and the various components of direct deposit management. You can always start by asking your existing bank about their service. It likely provides direct deposit management, and the bank’s terms and fees can give you a baseline for comparing your options.
2. Review federal and state laws on direct deposit.
Before you implement direct deposit for your business, consider the relevant federal and state laws. The complete rules regarding electronic funds transfer payroll payments can be found in the Electronic Fund Transfer Act (part of the Comptroller’s Handbook). These are a few of the federal law highlights:
- An employer is responsible for providing each employee with consent and direct deposit authorization forms.
- An employer must collect the employee’s bank information, including the bank name, account type, and routing and account numbers. The employee’s signature must be completed on the above forms.
- Although the employer may require the employee to accept direct deposit (depending on the case and state), the employee can choose the financial institution to receive the payments.
States are allowed to impose additional requirements for direct deposit. While some states only require employers to follow federal laws, most states have supplementary stipulations.
Fourteen states give employers the right to require employees to use direct deposit (according to federal law):
- Arizona
- Indiana
- Kentucky
- Maine
- Massachusetts
- Michigan
- North Carolina
- North Dakota
- South Dakota
- Tennessee
- Texas
- Utah
- Washington
- Wisconsin
Twenty-one states require an employee agreement before the employer can pay employees via direct deposit:
- Alaska
- California
- Connecticut
- Colorado
- Delaware
- Florida
- Idaho
- Illinois
- Iowa
- Maryland
- Montana
- New Hampshire
- New Jersey
- New York
- North Carolina
- North Dakota
- Oklahoma
- Pennsylvania
- Rhode Island
- Vermont
- Wyoming
Did You Know?
In Arizona, employees can agree to receive their paycheck via a payroll card or debit card. Arkansas gives employees the ability to opt out of direct deposit through a written statement. In Utah, employers are required to use direct deposit exclusively if $250,000 or more is paid in state payroll taxes or if at least two-thirds of their employees have an interest in direct deposit.
3. Collect information from your employees.
After you’ve signed up with your preferred payroll provider, you’ll need to collect information from your employees to process their payments. Each payroll service has its own direct deposit authorization forms, but the information requested is typically universal. Make sure every employee can safely and reliably deliver the following information.
- Bank information: The employee should provide the name and address of their bank and list the account holder’s name for the account they want to use for direct deposit.
- Key numbers: Three numbers are necessary to set up direct deposit: the employee’s bank account number (checking or savings), routing number (an ABA number) and Social Security number. The account number is obvious; it tells the provider where to deposit funds. The routing number is necessary for a digital transfer, and the Social Security number provides an additional identity check to ensure the money goes to the right person.
- Personal information: The employee’s name and address are standard requests; some payroll services may require more details. This is for verification purposes to avoid mix-ups and problems with deposit delivery.
- Consent and authorization: The provider must cover their legal bases and receive assurance that the employee understands and enters the agreement willingly.
4. Add employees to the payroll system.
Setting up your payroll system may take a little time, but once you have everyone’s information in the software, it should prove straightforward to manage. When new employees join your company, you can collect their direct deposit details as part of the onboarding process, which will speed things along. Additionally, automation tools can help you stay ahead of payroll and process everything quickly, easily and consistently.
Tip
An online payroll solution can help your bottom line even though you're paying for the service. There are multiple cheap payroll services you can use — just make sure to choose one that offers all of the features and tools you need.
5. Select your deposit schedule.
Once you and your payroll provider have the necessary information in the system, you need to pick a deposit schedule. There are a couple of things to consider here. The first is your financial schedule. Funds must be liquid and available for transfer in your business account before payments are distributed. Pick a payment schedule that works with your expected cash flow.
The second consideration is the payment time. Employees depend on those payments, and they need to be received promptly. Despite being digital, the process is not instantaneous when the ACH distributes funds to employees’ banks. On average, it takes two business days for the money to go from your business account to your employees’ accounts. Depending on the banks involved, the transfer may take longer during holidays.
For many small businesses, the transition to direct deposit happens in stages. Some employees may opt out. You might have to use a hybrid payroll system for a while, where some workers still get paper checks. The good news is that the automation available with direct deposit can make a hybrid system easier to maintain than a process where you write out checks for every employee.
Pros of direct deposit
Direct deposit, like most online innovations, offers many advantages in terms of speed and efficiency, making it a great option for both you and your employees. “Whether you are a 10-person operation or smaller, or a business of more than 100 employees, you can gain from direct deposit’s advantages,” McElrath said.
Here are some of the benefits of using direct deposit.
It saves your business money.
Direct deposit helps businesses save money by eliminating manual check preparation. Because there is no need for postage and mailing supplies, it saves business owners about $3 per paper check.
It saves your business time.
Saving money is always a bonus, but saving time is also a welcome win. When your entire staff adopts direct deposit, you’ll no longer spend time printing and mailing paper paychecks, and you’ll no longer need to wait for all of your employees to cash their checks to reconcile your business bank account. It also saves employees time, since they don’t have to wait in line at the bank to cash or deposit their paychecks.
It’s more secure than paper.
Direct deposit has a significant security advantage over paper checks, which can be lost, stolen or counterfeited. In a survey on payment fraud by the Association for Financial Professionals, researchers found that checks are the most vulnerable method to fraud. Additionally, according to a Nacha study, more than 75 percent of workers ages 22 to 34 who receive direct deposit cite security as one of the reasons it’s their preferred payment method. Offering direct deposit could even help you attract millennial employees.
It supports employees’ financial health.
Direct deposit lets your employees automatically direct part of their paychecks into their savings accounts or investment funds.
“With split deposit, employees can direct a fixed amount or percentage of their pay into a savings or investment account to help build savings,” McElrath said. “As the single biggest influence on employees’ use of direct deposit, businesses can play a key role in supporting employee financial health.”
Also, according to Kristin Walle, senior vice president of global payments and wage payments at ADP, most financial institutions offer free checking when employees use direct deposit, which saves them on banking fees. (Learn more about ADP’s payroll service below.)
It’s good for the environment.
A 10-person small business that pays employees twice a month via paper checks uses 10.7 pounds of greenhouse gases yearly — the equivalent of driving almost 40 miles. If the same small business switched from paper checks to direct deposit, it would save 3.7 pounds of paper, 35.7 gallons of wastewater from being drained into natural bodies of water, 1.4 gallons of gas and 4.3 pounds of solid waste.
Bottom Line
Direct deposit saves time, money and paper and is better for the environment.
Cons of direct deposit
There are some drawbacks of using direct deposit that you should consider for both your company and your employees.
It’s time-sensitive.
Direct deposit is time-sensitive, and it’s easy to overlook deadlines when you’re particularly busy. If you don’t collect your workers’ time and attendance sheets and process payroll by a specific time, the money won’t transfer into your employees’ accounts on time. Late payments can lead to disgruntled employees, and if you want to speed up the process, it can cost you extra if your payroll service doesn’t allow unlimited off-cycle payroll runs.
There are potential security risks.
Even though direct deposit is generally more secure than paper checks, there are still security risks. Because you need your employees’ bank routing and account information to set up direct deposit, you must have strong security measures in place to protect this sensitive information.
Changing banks means starting over.
Changing your business’s bank can be inconvenient because it means changing your direct deposit setup, so your employees must submit new authorization forms. If any individual worker changes their bank, they’ll have to update their direct deposit information with you to ensure they continue to receive their paychecks.
There’s no stop-payment option.
Although it’s convenient to use direct deposit, you can’t stop the payment like you can with a paper check, which might be an issue if you make a mistake. Thankfully, leading payroll services, some of which are highlighted below, help ensure error-free payroll processing. Payroll audits can also help you verify that everyone is being paid correctly.
You could incur overdraft fees.
If you don’t have enough money in your business bank account when the funds for payroll are withdrawn, it will put you in the negative and you’ll incur overdraft fees, which can be both inconvenient and expensive.
Best payroll services for direct deposit
We researched the best payroll services to find a variety of options for small businesses. These providers are more than capable of meeting your direct deposit needs:
- ADP: This vendor has a 70-year track record as an industry-leading payroll service and HR software provider, handling everything from attendance monitoring to business administration. ADP offers direct deposit, as well as special security measures for pay stubs. During onboarding, you can send new hires an invitation to submit their direct deposit and benefits information via ADP’s employee self-service portal. Learn more in our review of ADP.
- Gusto: We love that Gusto syncs with more than 20 time-tracking tools, which is helpful for ensuring employees are paid for the hours they work. Team members can receive direct deposits in their personal bank accounts or Gusto spending accounts. The vendor lets businesses choose between two-day, four-day and next-day transfers, depending on their plan. See a breakdown of the available packages in our review of Gusto.
- QuickBooks: This full-service payroll solution syncs seamlessly with the QuickBooks Online accounting software, which will help you manage your company’s funds. Not only does the vendor offer next-day direct deposit on its base plan, but you can get same-day turnarounds if you opt for a higher service tier. Plus, using the automated payroll option reduces your lift when you’re processing payroll. Get all the details in our QuickBooks Payroll review.
- Paychex: While Paychex is great for facilitating direct deposit, we appreciate that it also offers a number of alternatives, like an e-checks service. There is even a pay-on-demand offering. Meanwhile, the vendor’s mobile app is useful for running payroll on the go, while employees can use it to enroll in direct deposit and view their pay stubs. The app can also be used for timekeeping. Find out more in our Paychex review.
Direct deposit FAQs
Nacha is the National Automated Clearing House Association, also known as the Electronic Payments Association. This nonprofit manages the ACH Network, which processes and moves trillions of dollars annually. In 2023, the ACH Network moved 31.5 billion payments valued at $80.1 trillion. These transactions included direct deposit, Social Security, government benefits, electronic bill payments, and person-to-person and business-to-business payments.The ACH Network creates the grid for all U.S. financial institutions to transfer money from one bank account to another safely. Nacha is not a government agency, but it works directly with the Federal Reserve, state banking authorities and the Treasury Department. Nacha has its own rules and code of ethics that ensure business is conducted fairly and with as little risk as possible.
The cost to set up direct deposit varies based on factors such as your chosen payroll provider and your number of employees. Though direct deposit generally saves businesses time and money, you can be hit with service fees ranging from $50 to $149. Banks may also charge employers when money is transferred to an employee’s account. Individual deposit fees can range from $1.50 to $1.90 per transfer.Contact your financial institution or payroll services provider to learn exactly how much it costs to set up and maintain direct deposit. The financial institution or payment processor pays a fee to use the ACH Network, but Nacha does not track fees that a business may incur, according to McElrath.“Generally, [the] cost to use direct deposit [is] low,” she said. “Most companies would save money using direct deposit compared to other payment methods, and any startup costs would be recouped in savings and increased productivity.”FYI: You may want to consider partnering with a PEO payroll service, in which a professional employer organization becomes your co-employer and handles all tasks related to payroll.
According to Walle, direct deposit fund posting is governed by Nacha’s rules, which all financial institutions abide by. “As a result, the funds are available by 9 a.m. local time at the receiving depository institution on the settlement day," she said. "Many financial institutions ‘memo-post’ incoming transactions, so employees may see a pending transaction prior to funds being available.”Most U.S. employees who use direct deposit are paid at the opening of business on payday. If your company doesn’t have set paydays, you can use direct deposit to pay employees promptly using same-day ACH if your vendor allows it. The payment would be posted by 5 p.m. on the day the payments are made, McElrath said.
Yes, businesses can pay independent contractors using direct deposit. “While there may be differences in the specifics of how a contractor is administered in a payroll system, the money-movement mechanics are the same,” Walle said.The difference is that contracted workers are not required to fill out a W-2 form during the hiring process. Instead, they fill out W-9 forms, and you provide a 1099 form if you pay them $600 or more per year. Some payroll services have special rules or plans for paying contractors via direct deposit, so make sure you inquire if you're interested in this.
There are only a few reasons a direct deposit would be denied:
- The address on file doesn't match the one registered with the bank.
- There was an online payment failure.
- The routing number or bank account number has been entered incorrectly.
Most payroll vendors provide robust customer service, so don't hesitate to reach out if a problem arises.
Do employers have access to employee bank accounts with direct deposit?
No, employers do not have access to employee bank accounts with direct deposit. While an employer can request personal banking information or a voided check to set up direct deposit payments, it is illegal for an employer to gain access to your bank transactions and account balance.
Julie Thompson contributed to this article. Source interviews were conducted for a previous version of this article.
