Last year, the number of people living paycheck to paycheck rose by 9.3 million—with a total of 64% of all U.S. consumers living paycheck to paycheck.
The point? As inflation increases, so do the costs of goods and services, meaning your employees can afford less—especially if they’re faced with an emergency expense.
In fact, according to the Federal Reserve, 35% of Americans don’t have the savings to cover a $400 emergency, like a broken-down car or medical bill. In this kind of economic climate, employees are more likely to get trapped in a cycle of debt and other financial instability—which can, in turn, impact their work performance, morale, and reliability.
As an employer, you can help your employees weather these financial issues by offering payroll advances.
But offering this perk to your employees requires some prep and planning. Let’s look at how to do it right.
What Is a Payroll Advance?
A payroll advance is wages given to an employee early or before their actual payday. It’s essentially a short-term loan the employee pays back in future paychecks. It’s also known as a paycheck advance, wage advance, or salary advance.
How’s that work in action? Let’s say your pay period is twice per month—on the second and fourth Friday. However, on the third Tuesday of the month, an employee asks for a payroll advance to cover an unexpected expense.
If approved, the employee would receive all or some of their next paycheck early. Until the loan has been paid in full, all or some of the amount owed would be deducted from the employee’s next paycheck(s), depending on the terms of the advance.
Pay advances can accrue interest at a set rate outlined by your payroll advance policy (more on that later) and agreed upon by you and the employee requesting the cash—although many employers opt not to charge interest on these types of advances.
How Do Payroll Advances Work?
Now that you know what pay advances are, how do you make them work—for both your business and your employees?
- Establish guidelines and rules: Like other employee benefits, the process for requesting a payday advance should be laid out in a payroll advance policy.
- Approve the request and formalize it in writing: An employee’s request—and your approval/rejection—should be in writing (physical and/or digital). This paperwork should include the total amount of the advance, repayment terms (like payment installments), and any other necessary information to help resolve any potential future disputes.
- Provide and process the advance: After your employee signs a payroll advance agreement, pay out the advance. You can do this via cash, check, direct deposit, payroll debit card, or another payment method.
- Require a confirmation of receipt: After issuing the advance payment, require the employee to sign off on receiving it. Like the written request for an advance, this receipt can help prove you distributed the advance if there is ever a dispute in the future.
- Record the advance: Once the advance is paid out, record it in your bookkeeping or payroll processing software as an off-cycle payment. This is important for making sure your payroll deductions and tax withholdings are accurate and to ensure you don’t pay the employee twice for the same amount of work. (Generally, payroll taxes aren’t deducted from the advance payment itself; they’re deducted from the full amount of the paycheck the employee is getting the advance from.)
- Manage repayment: Finally, track repayment of the advance. Because an advance is repaid through future wages, make sure installments are properly deducted from each check until the advance is paid in full—including any agreed-upon interest or fees.
Pros and Cons of Payroll Advances
There are definite benefits to offering payroll cash advances—both for you and your employees. But this perk isn’t without its potential drawbacks—and before you decide to move forward with this kind of financial support, it’s important to understand both.
Let’s take a look at the pros and cons of wage advances:
- Make your compensation package more competitive: If you want your business to thrive, attracting top talent is a must. Providing the option for employees to access cash in a pinch—without falling victim to predatory practices like payday loans—can make your business more attractive than your competitors.
- Low risk: Salary advances are paid back by deducting funds from an employee’s next paycheck; repayments aren’t billed like credit card payments or personal loans, so there’s little risk that an employee will default on paying.
- Improve employee morale and engagement: According to research from SoFi, 84% of employees claim that financial benefits impact their job satisfaction and engagement. Providing an additional perk, like a paycheck advance—can help to retain talent and improve workplace morale.
- Increase productivity: When employees feel financial stress, your business can take a hit. According to research from PwC, 18% of employees reported that money worries had a severe or major impact on their productivity at work, with 15% of employees reporting a severe or major impact on their attendance. A paycheck advance can reduce some of these concerns—and ensure your employees are present, focused, and able to get their work done.
- Potential for compliance issues: Offering advances means you must follow specific laws and regulations for how they’re managed and used (or face hefty fines)—for example, the Truth in Lending Act (TILA) requires lenders (in this case, you) to disclose certain information about a loan, like its repayment terms and interest rate/APR. Additionally, though the federal Wages and the Fair Labor Standards Act allows for payroll deductions used to pay back a loan to reduce an employee’s pay below minimum wage, some states prohibit this—so it’s important to review your state’s labor laws, too.
- More complex and time-consuming accounting: Processing off-cycle payments and following up on repayment can complicate your payroll and accounting, leading to increased labor costs.
- Negative impact on cash flow: When you offer an advance, you’re fronting funds that an employee hasn’t earned yet. If an employee quits or is terminated before repaying an advance, your business could be on the hook for the unpaid balance.
- Possibility for employees to abuse or misuse the process: Some employees might ask for advances too often, essentially growing reliant on early payments. Others might request an advance before a no-call no-show, getting paid for work they never completed.
How to Make Payroll Advances Work for Your Business
You know how salary advances work—and the pros and cons of using them at your small business. Now let’s look at what you should do to make sure advances benefit you and your team.
Understand Laws and Limitations
Before you start offering advances, make sure to review federal, state, and local employment laws. These laws specify interest rate limitations, what fees you can charge (if any), repayment terms, and other regulations surrounding cash advances, including:
- The Truth in Lending Act (which requires lenders to disclose information about a loan or advance payment)
- The maximum interest rate and APR you can charge
- What, if any, fees you can charge (such as an administrative or origination fee)
- Ensuring that an advance doesn’t reduce an employee’s pay below minimum wage (if that law applies to your state or region)
- The need to charge the Applicable Federal Rate (AFR) on personal loans or recognize the difference as taxable income to the employee for any advances that exceed $10,000
- If you’re legally allowed to deduct money from an employee’s next paycheck (for example, California only allows paycheck deductions when an employee agrees to the deduction in writing)
As with other employee benefits, you need to set clear criteria for who qualifies for a payroll cash advance (and who doesn’t). This can depend on their length of service, position, type of employment (like part-time or full-time), seniority, or pay rate.
Establish a Maximum Amount
Limiting the amount of money an employee can request in advance can help you maintain a healthy cash flow while continuing to support your workforce. Consider how much money you could feasibly lend based on your company’s financial strength and how quickly and easily employees would be able to repay the loan amount.
Consider Limiting the Frequency of Requests/Approvals
A salary or wage advance can help get an employee out of a tight financial spot. But it should be reserved for emergencies and unexpected expenses.
To that end, consider limiting how often employees can request an advance to reduce the potential for abusing the policy.
For example, allow one request per quarter and/or specify that advance requests will be rejected during periods of economic instability or limited cash flow. (If an employee has a genuine emergency that falls outside of your set parameters, you can opt to evaluate on a case-by-case basis.)
To make sure everyone is on the same page (and avoid future disputes), outline the process and procedures for requesting and repaying a cash advance in a payroll advance policy. Be clear about:
- How to submit requests
- How often an employee can request an advance
- The maximum amount an employee can receive in advance
- How advances are paid out
- Repayment terms (including installments or pay periods, APR and interest rates, and fees)
As mentioned, it’s important that an employee’s request is made in writing—and they sign off on a written agreement before any cash is paid out or transferred to their bank account.
To keep things simple, consider providing employees with a payroll advance form they can fill out with details about their request (like the amount of money they’re requesting and their preferred payout method).
Offer Financial Literacy Education or Alternative Support
To help prevent your employees from needing advances, consider offering financial literacy education, like on-site workshops or a financial literacy stipend.
This can help your workforce learn everything from how to better manage their finances, prepare for unforeseen expenses, pay down debt, or stick to a budget.
What about alternative support? Payment methods—like on-demand pay, a service offered by some payroll providers that gives employees on-demand access to a portion of their wages as they earn them—can reduce the risk you would incur from offering an advance while still providing employees with access to cash before payday.
Still have some questions about wage advances? Let’s look at some frequently asked questions.
How Can I Get a Payroll Advance?
In order to get a salary advance, you need to ask your employer for one. Get in touch with your human resources department (or whoever manages pay and benefits) to learn about the process.
What Apps Let You Borrow Money Instantly?
Cash advance apps like Albert, Chime, and Dave let workers borrow money instantly, with repayment typically due on your next payday. Though these apps’ fees can result in a high APR for borrowing money, they typically don’t check your credit score—and can be useful if you need cash in a pinch.
How Are Payroll Advances Different from Payday Loans?
Payday loans are offered by third-party payday lenders and typically carry much higher interest rates and APRs than payroll advances.
This makes payday loans a dangerous alternative to an advance or conventional loan and can worsen a borrower’s financial situation—even if the loan is paid on time. In fact, payday loans are so potentially harmful that 18 states ban or heavily regulate their use.
How Are Payroll Advances Different from Employee Loans?
Though an advance is a type of loan, repayment is tied to an employee’s future earned wages, so it’s generally less risky for the company.
Interest is also limited (if it’s charged at all).
On the other hand, an employee loan is a more conventional type of financing in which the employer is paid back via installments—and typically accrues interest (just like your car loan or mortgage).
Payroll Advances Can Help Employees Get Through Financial Difficulties
As a small business owner, your team’s health and well-being have a significant impact on their productivity, engagement, and satisfaction.
Offering them an avenue to deal with an unexpected financial emergency shows that you care about their happiness and can help them avoid making other desperate decisions that could affect their lives, and your business.