How to set up direct deposit for your employees

Is your small business still printing payroll checks? As your business grows, processing checks can become complex and time-consuming, and errors can be costly. 

Setting up direct deposit for your employees is an easy way to improve efficiency, increase employee satisfaction and minimize costs. With direct deposit, employees receive their paychecks directly in their bank accounts, saving time for you and your team. 

You might think direct deposit is only an option for a large business with many employees, but it’s possible to set up direct deposit even for very small businesses. You can set up this payroll processing method for just one person. 

This guide will walk you through how to set up direct deposit payroll — from gathering essential information to implementing and maintaining a smooth, efficient direct deposit system.

Direct deposit: Understanding the basics

Direct deposit transfers funds electronically from your company’s payroll account into employees’ bank accounts via the Automated Clearing House (ACH) network. ACH is a regulated system for electronic money transfers between financial institutions. This network ensures secure transfers and prevents issues like lost,  delayed or returned paychecks while also protecting sensitive employee information.

Because of its convenience, speed and security, direct deposit has become the standard way Americans get paid. According to the American Payroll Association, more than 95 percent of workers receive their pay via direct deposit.

Pros and cons of direct deposit

Although direct deposit can bring significant benefits for employers and employees alike, it’s essential to weigh the pros and cons before implementing it in your business.

Let’s discuss each of these pros and cons in depth. 

Pros

Cost-effectiveness

Issuing paper checks is a costly manual process. Each check requires administrative labor for approvals, signatures, printing, envelope stuffing and mailing.

A recent report found that the median cost of issuing a paper check ranges from $2.01 to $4.00. In contrast, ACH payments typically cost a fraction of that price — around 40 cents.

Reliability

Direct deposit minimizes the risk of human error, making payroll more reliable, cost-effective and efficient as payments are calculated and sent electronically. 

When issuing payroll checks, a sick staff member could cause payroll to be delayed. Even worse, bookkeeping errors could lead payroll checks to bounce. Both situations can damage your relationship with employees and, in some states, even open you up to lawsuits and penalties. 

Speed

Processing checks and handling check runs is time-consuming. Switching to direct deposit can save your staff a lot of time. Also, your employees can receive funds faster  — sometimes even early — which improves employee satisfaction.

Security

Because they are processed digitally, direct deposits are a more secure option that reduces the risk of fraud. In contrast, checks can be lost, stolen, altered or damaged.

Flexibility

Direct deposit systems often allow employees to split their paychecks into different accounts, such as checking and savings. Your employees will appreciate the ability to streamline their finances.

Cons 

Cost

Depending on the payroll provider or bank, direct deposit may involve setup fees. Also, each transaction typically requires a fee for ACH processing, so it’s essential to assess these costs before making the decision. Payroll providers typically start at around $40 per month plus $3–$6 per employee per month. Compare those fees to the cost of a traditional payroll system, including labor, postage and materials. 

Employee opt-in

What happens if one or more employees don’t want to receive direct deposit? Maybe they don’t have a bank account or they don’t trust electronic banking. State laws vary, but under federal law, you can require your employees to accept direct deposit only if you offer at least one alternative, such as a paper check or prepaid debit card. That means you may have to keep track of more than one payroll system. 

Alignment with the banking system

Direct deposit relies on both the ACH network and employees’ banks. Any disruptions in these systems can delay payroll processing. Employers also need to run payroll according to the banking calendar, which means small businesses must familiarize themselves with ACH timelines. 

Steps to set up direct deposit

Setting up direct deposit for your business involves a few important steps. Here’s a guide to help you make a seamless transition.

1. Select a bank or payroll provider 

If you’re processing payroll in house, contact your bank about direct deposit options and associated fees. Some banks charge small fees per transaction, while others might offer packages for small businesses. Many full-service payroll providers include direct deposit along with added support for payroll, compliance and tax needs. 

Here are some of the most popular payroll services that include direct deposit features: 

You can also set up direct deposit through the payroll features of popular software packages, such as Intuit Quickbooks and Wave Payroll. 

2. Collect employee information

Once you’ve decided on a provider, distribute a direct deposit authorization form to employees to collect their banking information and obtain permission for electronic payments.

You’ll need to collect:

• Bank account number and routing number: These allow the ACH system to transfer funds to the correct accounts. 
• Account type: Employees can choose a checking or savings account or even split their deposits across both account types.
• Authorization form: Employees must complete an authorization form, available from your bank or payroll provider, to share their bank details and consent to direct deposits. This form is also essential for compliance, as it authorizes the company to send payments electronically.

3. Ensure the information is secure

You must ensure the confidentiality and integrity of employee payroll data to avoid legal and financial consequences. A data breach can lead to severe repercussions, including penalties under privacy laws. You may also be held responsible for any financial losses employees experience due to a breach.

The easiest way to do this is to choose a direct deposit provider with a strong reputation for security and have your employees enter information directly into their systems. That way your company never becomes directly responsible for sensitive data, as it’s never stored on your computers. 

Never ask employees to send bank account information through email, text or insecure messaging systems. 

4. Input information into payroll software

Even if your employees input their bank account information directly into the payroll system, you’ll still need to enter some information on your end.

For example, you’ll need to set up:

• Pay rates
• Tax details
• Any garnishments or other adjustments to wages
• Pay periods
• Tax deduction and other payroll settings

You’ll also need to link your payroll bank account.

5. Conduct a test transaction

Many businesses opt to run a test transaction, called a prenote, to verify account details. This test sends a small amount — typically no more than a few cents — to verify that funds are sent to the correct account.

It’s an optional step but can help ensure accuracy before processing larger payroll amounts.

6. Schedule payroll and direct deposits

Set a payroll schedule and ensure your system is configured to deposit funds on payday or the day before. Typically, ACH transfers take one to two business days to process, so make sure to account for this timeframe when processing payroll to avoid delays.

7. Notify employees

Once direct deposit is set up, let your employees know when it will begin and provide guidance on checking their deposits. Many payroll providers offer employee portals where workers can view pay stubs and manage their deposit information.

Common errors to avoid

Automated systems make everything easier — but they can magnify any errors in your system. It may be more difficult to spot those mistakes without paper checks passing through people’s hands. 

Here’s what can go wrong with payroll and how to avoid these errors in your new direct deposit system:

• Incorrect bank information from employees: Check for accuracy by running a small test transaction to confirm the account data.
• Misclassifying employees: Double-check that you correctly separate independent contractors from employees.
• Disorganized recordkeeping: If your payroll information is scattered across different apps or paper systems, consolidate and streamline it before you set up direct deposit. 
• Miscalculating pay: Have more than one person double-check your payroll system to be sure overtime, paid time off, commissions, bonuses and rate changes are set up properly. 
• Not including garnishments: If you’re responsible for withholding child support, tax payments or any other garnishments from employee wages, set them up when you automate your payroll for direct deposit.

The bottom line

Direct deposit is an efficient, secure payroll solution that can benefit your business and your employees. It reduces costs, minimizes payroll errors and provides employees a reliable, convenient way to access their wages.

To get started, first check your bookkeeping software to see if it offers a direct deposit option. You might also consider fully outsourcing your payroll to a payroll provider like Gusto, ADP or OnPay. These services help employees and contractors track their hours and paychecks while allowing you to manage their pay and comply with state laws and tax requirements. 

Setting up direct deposit takes some initial effort, but the long-term convenience and security usually make it well worth the change.

Frequently asked questions

• Are direct deposits secure?
  

  Direct deposits are more secure than paper checks, which can be lost, stolen or damaged. They are processed through the Automated Clearing House network, a highly regulated system for electronic money transfers between financial institutions.

• How long does it take to set up direct deposit?
  

  Setting up direct deposit can take a few days to several weeks, depending on the size of your staff and whether you conduct a test deposit.

• How much does it cost to offer direct deposit for employees?
  

  Costs vary depending on the payroll provider or bank. Some providers charge per transaction, while others may include direct deposit services within broader payroll packages. For instance, if you’re already using Quickbooks Payroll, you’ll pay an additional $4 per employee each pay period. Square Payroll starts at $35 per month plus a $6 monthly fee per employee. Gusto has payroll plans starting at $40 per month, plus you’ll pay $6 per month per person for direct deposit.