Paycheck advance: how to help your employees

No matter how much money you make, financial emergencies can happen. As a small business owner, you might be faced with a situation in which an employee requests a paycheck advance. You might also be asked questions about this process, and if it’s something your payroll team offers. Below are some common practices for providing a payroll advance, and tips for how to make it easy for both you and your employee.

• What is a paycheck advance?
• How to talk to your employees about paycheck advances
• Benefits and drawbacks
• How to avoid complications
• How to complete a paycheck advance
• For the employee
• For the employer

• Final paycheck advance considerations

What is a paycheck advance?

A paycheck advance is an advance on a future paycheck that would normally come from an employer’s payroll cycle. Considered a short-term loan, a paycheck advance is agreed upon by both the employer and the employee and is typically repaid back to the employer from future paychecks. This is an optional benefit and intended only to be used in an emergency situation, such as a large unexpected expense. Because the employee is borrowing money from the next payday, paycheck advances should be used sparingly and with caution.

When speaking with your employee, they might mention the term “payday loan” or “cash advance.” It’s important to understand that a paycheck advance and a payday loan are not the same, even though they are often interchanged or confused.

Whereas a paycheck advance is a hassle-free, employer-based loan, a payday loan is provided through an outside payday lender at a much higher cost, usually $10–$30 per $100 borrowed . In some cases, payday lenders target individuals who need cash immediately and may not have other funding options available. In these cases, payday lenders are able to charge high interest rates and may charge additional fees if payment is not paid back on time. This is a different circumstance from the predominantly interest-free paycheck advance from the employer.

Before agreeing to take or provide a paycheck advance, the following benefits and drawbacks need to be considered:

Benefits to the employee

Some benefits of a paycheck advance to the employee include:

• Immediate payout: If an employee requests a paycheck advance, it’s likely because they need access to funds quickly. A paycheck advance can be especially helpful when employees are faced with an unexpectedly high expense, such as a medical bill or car repair. Funds can often be sent via direct deposit to your bank account or credit union and may be available within a business day or two, depending on the employee’s financial institution.
• Ease of access and repayment: When discussing a payday advance with your employee, you’ll want to agree on repayment terms. Your employee will benefit from flexible repayment options if you’re able to offer them. You may agree to full repayment of the advance on the employee’s next pay period or on installment payments over a series of payroll cycles. Having the funds repaid by payroll ensures that the repayment will not tack on any overdraft fees to the employee’s checking account, which could cause more of a financial problem.
• Better terms: Unlike other money advance options like personal loans, a paycheck advance typically carries better terms. This helps the employee overall as you would not be charging large interest rates, late fees, or an annual percentage rate in the same way that other options do.

Benefits to the employer

While there are obvious benefits to the employee who is requesting a paycheck advance, offering paycheck advances when your employees need them can have some important benefits for your business as well:

• Competitive advantage: A policy for paycheck advances shows your employees that you can help support them when financial emergencies happen. While this might not seem as enticing as other benefits such as health insurance, it certainly won’t be overlooked by employees.
• Retention: By offering this type of benefit, you reaffirm to your employees that you care about their overall wellness, which can help you improve employee retention.

Drawbacks to the employee

While getting the funding they need has immediate benefits to employees, it’s important to note that there can be some drawbacks of paycheck advances too. These can include:

• Smaller paychecks: Until the debt is paid, subsequent paychecks will be less. For some employees, this might not be an overwhelming problem, however, for employees who are financially struggling, this could make the situation worse.
• Amount that can be deducted: The deduction from an employee paycheck cannot reduce the pay to less than the federal hourly minimum wage. Depending on the employee’s wage, this might mean that the repayment will be spread out over multiple future paychecks, which could be detrimental to the employee’s financial situation.

Drawbacks to the employer

While it’s mostly beneficial for the employer to offer this type of benefit, paycheck advances do not come without a potential drawback:

• Lack of repayment: While unlikely, it’s not impossible that an employee will either quit or be terminated before the repayment is made, costing the company money.
• Disruptions to the payroll cycle: This is the largest disadvantage for you as an employer. Paycheck advances can have a hefty impact on your books and payroll, not to mention an increase in paperwork overall. Also, your business must be able to financially support the advance without disruption to any other typical payroll processes.

The best way to avoid complications with this type of request is to have a written policy in place, preferably before an employee needs the benefit. It can be helpful to define:

• Who is eligible
• How much they are able to advance
• How often this benefit will be available
• How the repayment will take place

While you may want to make every employee eligible, it might make more sense for your company to limit the benefit to employees who have a certain tenure, or to limit it to employees who are in good standing with your company. You must also take into consideration the employee’s compensation type before agreeing to any advance.

Employers wishing to offer this option might also consider offering educational materials for financial literacy and financial planning to employees. While this might not mitigate the potential downfalls, it will provide a base of information to protect both parties and potentially lessen the need for paycheck advance requests in the future. Topics such as setting up an emergency fund, lowering credit card debt, or setting up and managing a savings account are great first steps.

There are a few steps to take once an employee asks for a paycheck advance, both by the employee and by the employer. More specifically, the following needs to be done as soon as the request is made:

For the employee

There are a few specific steps the employee must take to successfully request and be granted a paycheck advance, including:

1. Put everything in writing: Having everything in writing is a key element in making a paycheck advance successful for all parties. If an employee verbally asks for a paycheck advance, your first step is to ask the employee to put the request in writing.
2. Have a conversation: Once the request has come through in writing, the next step is to review and discuss an employee pay advance agreement. You can draft one up yourself or you can use an employee paycheck advance agreement form template. This includes:Employee name
3. Date of disbursement
4. Total loan amount
5. Timeframe for repayment
6. Contingency for repayment if the employee is terminated
7. Employee and employer signature and date
8. Discuss next steps: After going over the pay advance agreement form, discuss next steps and any questions the employee may have. (They might ask if they will be owed any retroactive pay, for example.)

For the employer

As the employer, there are a few steps to take to help make a paycheck advance as smooth as possible.

1. Before choosing to provide this benefit to your employees, it’s important to choose a payroll provider, if you haven’t already. A service like QuickBooks Payroll can help you get organized for this exact situation.
2. When a pay advance is agreed upon, a nontaxable money type must be added to payroll, which will be used to pay the advance.
3. Once the advance is paid, a deduction needs to be made for future payroll cycles. It’s important to add the deduction to the employee’s payroll records so that a set amount will be automatically deducted until full payment is remitted.

Outside of the actual process, remember that confidentiality is key in this delicate circumstance. While you might want to confirm that the advance is necessary, you shouldn’t inquire what the money is going toward. This not only builds rapport with your employee but eliminates any potential discrimination accusations in the future.

Final paycheck advance considerations

Remember that the employee who is asking for a paycheck advance has most likely exhausted all options. Working with payroll to offer a paycheck advance to employees is sure to be beneficial and greatly appreciated.