How to Offer Payroll Advances

What is a payroll advance?

A payroll advance is a financial agreement between an employer and an employee. The employee receives money from the employer through a short-term loan. The loan is paid back to the employer via future earned wages. Agreement terms can vary; however, all parties should understand and agree upon payroll advance and repayment terms before the advance is made.

Payroll advances can help employees avoid payday loans with predatory lending practices. According to Vantage Market Research, the payday loan market will grow to $42.6 billion by 2028. These loans often incur exorbitant interest that causes anxiety for borrowers and, by association, the employers they work for. Loans range from $100 to $1,000, with an average loan term of about two weeks; finance charges can range from $15 to $30 for borrowing just $100.

How does a payroll advance work?

A payroll advance always begins with an employee submitting a written request. Having each payroll advance request in writing creates a paper trail that can be helpful if any issues emerge with the employee (refusal to pay back the advance, termination, etc.).

Once an employee submits the written request to be processed through payroll, both parties (employer and employee) must sign an agreement. The written request should include a payment plan to ensure your company receives its money back on time.

The best payroll services and software can quickly and seamlessly process payroll advances. However, if you manually process payroll, you must arrange a separate check or electronic deposit for the employee. You must also note the extra payment in your payroll register so your books reflect the payroll advance.

Employee loan vs. paycheck advance

Employee loans differ from payroll advances. An employee loan is a sum of money the employee predetermines. The employer must approve the amount; the employee uses future income to repay the loan in agreed-upon installments.

With an employee loan, the employer is not guaranteed to get the loan money back. If the employee defaults on payments or frequently makes late payments, your revenue stream may be impacted.

In contrast, a paycheck advance offers the employee money they’ve already earned; they’re usually requested and processed a few days before payday. A paycheck advance is less risky for the employer because the employee has already acquired the money and the employer controls payroll.

Pros and cons of offering paycheck advances to employees

While offering payroll advances can benefit employees and businesses, there are some potential drawbacks to be aware of.

Pros

• Less stress: A payroll advance can reduce an employee’s financial stress.
• Avoids payday loans: A payroll advance helps employees avoid the high finance rates payday loan companies charge.
• Potentially higher employee productivity: Minimizing an employee’s financial stress can lead to higher productivity and reduced sick leave or time off.
• Higher employee engagement: Employers benefit from a more productive and engaged employee. Payroll advances may strengthen employee-employer relationships and reduce turnover. 
• Potentially higher revenues: Focused employees who are engaged and productive may help create higher revenues for the business.
• Better recruitment efforts: A loyal and engaged workforce can help boost companies’ talent acquisition efforts. 

Cons

• Paperwork and red tape: Payroll advances may increase administrative paperwork. You must ensure you understand HR compliance issues, minimum wage requirements, overtime laws and the federal Truth in Lending Act.
• Potential cash flow issues: To offer payroll advances effectively, businesses must be financially sound with sufficient cash flow. Employees might become dependent on payroll advances, leading to an “advanced paycheck-to-paycheck” lifestyle that isn’t healthy for the employee or the employer.
• Strained relationships: Payroll advances can lead to strained employer-employee relationships if there are disagreements or misunderstandings related to repayment terms.

Companies can address some of these drawbacks by limiting how many payroll advances an employee can have per year. This helps keep this benefit in check and avoids confusion about payroll advance policies. In addition, payroll advance policies can outline situations where payroll advances may be reduced or unavailable, such as during an economic downturn, when the employee has taken time off or when workers’ compensation is involved.

How to avoid problems with payroll advances

Before offering payroll advances to employees, businesses must have policies in place that address the following issues:

1. Determine how the payroll advance process works.

There should be a clear and discreet way for an employee to request a payroll advance. For example, an employee could fill out a form; if the advance is approved, the employer and employee will sign a document. The form should include all the terms involved, including fees, interest, the agreed payback time frame and any company-specific terms. If the employee does not hold up to their end of the payroll advance, they could face disciplinary action, termination and/or legal consequences.

2. Define who is eligible for a payroll advance.

Specifying eligibility helps you streamline who can receive a payroll advance. Eligibility guidelines are especially helpful if funds are limited or a particular workforce segment has burned you in the past. For example, you could offer payroll advances to full-time employees but not part-time workers. Or you could specify that the employee must complete a particular work period with your company to show their commitment before you’ll consider them for a payroll advance.

3. Set advance minimums and maximums.

Place a cap on the dollar amount of payroll advance each employee can receive within your policy. A cap will help you get your money back and help the employee become financially responsible.

4. Keep all terms in writing.

Include all aspects of payroll advances in written policies. Ideally, the same policy should be used with every employee and include all terms. The employee should be aware of these terms; the employer and employee should agree on deduction amounts and when the deductions will begin and end. Both parties should sign the agreement, and a copy should be placed in the employee’s file.

5. Integrate the payroll deduction with your payroll software.

Keeping up with changing payroll taxes, compliance issues and payroll deductions is often more than businesses can handle. Save time and money by investing in a top-notch payroll solution. For example, read our ADP payroll review or our review of Paychex to learn about online payroll solutions that can help you manage payroll advances and much more.

6. Set the payroll advance frequency.

Ensure your payroll advance policy includes how frequently employees can request advances. You want to avoid employee confusion and potential legal action. Most companies limit their employees to a payroll advance once every six months or twice per year.

Additionally, add a clause that prevents employees from receiving a payroll advance if they haven’t paid back a previous one. Too much leniency on this policy could result in a significant loss of cash flow for your business.

7. Offer financial education.

After writing a payroll advance policy, consider providing employees with additional resources. For example, when an employee asks for a payroll advance, you could offer financial counseling or provide them with free online financial courses to help them improve their situation in the long term. 

Assist your team and boost employee satisfaction

Payroll advances can be an excellent employee engagement strategy that boosts loyalty and eases stress. By providing employees with financial assistance, employers can demonstrate their commitment to a positive work-life balance and employee well-being. Employee-centric policies like payroll advances can even help boost retention and show your employees you’re on their side.  

Linda Pophal contributed to this article.