6-Step Guide to Setting Up Direct Deposit for Employees

Direct deposit is the electronic transfer of a paycheck directly into an employee’s bank account. Instead of issuing a paper check, the employer initiates an Automated Clearing House (ACH) transfer that routes the funds straight to the employee’s bank.

Employers choose to pay employees by direct deposit for several reasons. It’s faster, more accurate, and easier to manage than paper checks. It reduces the cost of printing checks. And it also lowers the chances of lost or stolen checks.

Direct deposit is also better for employees. Payments arrive automatically in their bank accounts, eliminating the need to physically visit a bank. It also ensures uninterrupted access to wages when employees can’t come into the office to pick up a paper check.

If you’re interested in getting rid of paper paychecks and moving to direct deposit, learn how to set up direct deposit for employees in six simple steps using this guide.

What is direct deposit?

Direct deposit is an electronic payment method that transfers funds directly from a payer’s bank account to a recipient’s account, eliminating the need for paper checks. It’s commonly used for payroll because it offers a secure, fast, and convenient way to pay employees.

The benefits of using direct deposit for payroll

Paying employees via direct deposit delivers several benefits:

• It’s more convenient: Employees receive their wages directly into their bank accounts, eliminating the need to pick up or deposit paper checks.
• It’s faster: Electronic payments are processed faster than traditional methods. Employees can often access their income on payday, and the payments are removed from employers’ bank accounts with no delay.
• It’s cheaper: Employers save on the direct costs of printing paper checks, as well as the indirect costs related to the time it takes to distribute and reconcile checks.
• It’s more secure: Direct deposit reduces the risks of lost or stolen checks and fraud.
• It’s environmentally friendly: Not using paper contributes to environmental sustainability.
• It’s more reliable: Employees can still get their paychecks even when they’re off of work or unable to access their workplaces.

The disadvantages of using direct deposit for payroll

While direct deposit is an efficient and widely used method for paying employees, it does have some potential disadvantages that employers should consider before making the switch:

• The process of setting up direct deposit for each employee can be time-consuming, especially if you’re managing a large workforce.
• Direct deposit relies heavily on technology. While uncommon, downtime, server failures, or issues with the bank’s system could lead to delays in employees receiving their pay.
• Handling direct deposit involves securely storing sensitive banking information, making you more vulnerable to cybersecurity threats like hacking or phishing attacks.
• Employees without a bank account cannot receive their pay through direct deposit, so you may need to offer more than one option for employees to receive their pay.
• If there’s a mistake in the payroll calculation or an incorrect direct deposit, it can be harder to trace and resolve compared to manually handling checks.

How to set up direct deposit for employees in 6 steps

Setting up direct deposit for employees is a straightforward process, but it involves a few key steps to ensure everything runs smoothly. Here’s a step-by-step breakdown.

Step 1: Choose a payroll provider

To pay employees by direct deposit, you’ll first need a way to initiate ACH transfers. While you can set this up yourself through your bank (more on that below), most businesses opt to use a payroll provider for this.

A payroll provider handles the entire process of paying employees for you. It calculates employees’ wages, taxes, and other deductions and automatically sends the funds to recipients. Payroll providers also stay up to date with tax laws to ensure you’re always compliant.

Using a payroll provider like Buddy Punch, you can track employees’ hours, calculate their pay, and process payroll in a single system. Buddy Punch will automatically calculate tax rates and other deductions for you to determine how much you need to pay each employee. Then, it will send them their wages via direct deposit.

How much does it cost to set up direct deposit for employees?

The cost of using a payroll provider for direct deposit varies depending on what features the provider offers. In general, you’ll pay a flat per-month fee that ranges from $35-$85, plus a per-employee monthly fee of $6-$12.

For a business with 10 employees, you’re looking at $95-$205 per month for direct deposit payroll services. With 50 employees, the cost would be in the range of $335-$685 per month. For 100 employees, you’re looking at a monthly cost between $635-$1,285.

While these costs might seem high, they’re typically much more cost effective than running payroll and initiating direct deposits yourself. Because payroll providers automate a lot of the work for you, your time savings are likely to be much higher than the cost of the service.

Can I set up direct deposit myself?

To avoid the cost associated with using a payroll provider, you might be curious to know if direct deposit is something you can set up yourself. While it is technically possible, it’s a complex process that requires a direct relationship with a bank and adherence to strict regulations. Here are the steps you’d need to do through:

• To initiate direct deposits, your business needs to become an “Originator” within the ACH network. This typically involves establishing an agreement with your bank, known as the Originating Depository Financial Institution (ODFI). The bank will assess your business’s creditworthiness and operational capabilities before granting this agreement.
• For each pay period, you need to create ACH files containing the payment instructions for each employee. These files must be in a specific format that complies with National Automated Clearing House Association (NACHA) standards. This typically involves using specialized software or having a deep understanding of the file specifications.
• Once the ACH file is generated, you need to securely transmit it to your bank according to their specific procedures and deadlines.

For this reason, setting up direct deposit yourself is generally not recommended for most small businesses due to the administrative burden, potential for errors, and compliance complexities.

Related reading: How to Do Payroll Yourself

Step 2: Enter your business’s direct deposit information

Before your payroll provider can initiate ACH deposits for you, you’ll need to set up your business and bank account in the system. You’ll need to provide:

• Your business’s bank account information (routing and account number).
• A voided business check or bank letter for verification.
• A signed authorization form for ACH payments.

The provider will use this information to debit your account each pay period and transfer funds to your employees. 

You may also have to verify your bank account to prevent fraud and ensure accuracy before you can proceed with paying employees. The payroll provider will send a few small test deposits to your bank account. Then, you’ll report back to the payroll provider on what those amounts were to validate your ownership of the account.

Step 3: Gather the necessary information from your employees

Next, you’ll need to gather key details from your employees in order to pay them. You’ll need some basic information that will be used to calculate tax withholdings and submit payments to tax agencies on their behalf, as well as their bank account information to pay them via direct deposit. Here is the employee information that’s needed for direct deposit:

• Full name
• Home address
• Date of birth
• Social security number
• Bank name
• Routing number
• Account number
• Account type (e.g., checking or savings)

For basic information like name, address, and SSN, you’ll want to collect this in a W-4 that not only contains that information but also helps your payroll provider know how much they should withhold from an employee’s paycheck for taxes. For the bank information, you can collect this as part of an authorization form that lets employees opt-in to receiving direct deposits.

The good news is that payroll providers like Buddy Punch let your employees enter all of this data into the system for you. When they log in, they’ll be prompted to provide all of the information you need, so you won’t have to create custom forms for gathering the information and enter it all into the system yourself.

Step 4: Enter the employee information into your payroll software

If you collected all of the details above manually on paper forms, your next step will be to enter that information into your payroll software for each of your employees.

If you’re entering the data manually, it’s really important to double-check the information for accuracy. Errors at this stage can cause missed payments or delays, and it’s not as simple to recover direct deposits into the wrong accounts as it is to void a paper paycheck.

Your payroll provider may also encourage you to do a test or preview run at this stage to ensure funds are routed correctly. This allows you to verify amounts and check how deposits will appear on employees’ bank statements and paystubs.

Step 5: Establish a payroll and direct deposit schedule

If you’ve been paying employees by paper checks, you probably already have pay periods set up. However, direct deposits can take longer to process — between one and four days depending on your provider — so you may need to make adjustments to your existing process in order to make sure employees receive their paychecks on time.

For example, if you want your employees to be paid on a Friday, you may need to process payroll on Monday to make sure payments are deposited into their accounts by Friday. This may require switching up when you run payroll or altering the start and end times for your pay cycles. You’ll also need to account for any holidays that could delay payments.

It can be helpful to look at the calendar for the entire year and pre-schedule the days you’ll work on payroll to make sure nothing unexpected pops up that will delay employees from getting their earnings.

Related Reading: How to Choose the Right Pay Period Length for Your Business

Step 6: Run payroll

Now that you have everything set up, you’re ready to process your first payroll using direct deposit. You’ll enter your employees’ time data into the payroll system (unless you’re using a system like Buddy Punch that does this for you automatically), validate the wage amounts, and let your provider know you’re ready to process payments.

You’ll want to monitor for errors during processing, particularly after your first payroll run. However, errors are something you’ll want to keep an eye out for during every payroll run.

Common direct deposit errors

While direct deposit is an efficient and reliable payment method, errors can still occur during the process. Here are some of the most common direct deposit errors you may encounter:

• Incorrect bank details: One of the most common errors occurs when either the account number or routing number provided by the employee is incorrect. This can result in the funds being deposited into the wrong account or being rejected by the bank.
• Incorrect pay: Employees may receive more or less than what they were supposed to be paid due to incorrect calculations or incorrectly formatted reports.
• Outdated records: Sometimes, employee data may not match up with the payroll system, such as outdated addresses or banking details that were not updated by the employee. This can lead to failed or delayed direct deposits.
• Late deposits: If you don’t finish payroll on time or didn’t account for a holiday delaying bank payments, employees’ funds might be deposited later than expected.
• Insufficient funds: If your bank account doesn’t have enough funds to cover payroll, the direct deposit transactions may fail.
• Incorrect deductions: Errors can happen with deductions for taxes, benefits, retirement, garnishments, etc., leading to discrepancies between an employee’s actual and expected take-home pay.

To avoid these errors, make sure to stress to your employees the importance of keeping their information up to date in the payroll system. It’s usually really easy to encourage employees to be proactive when not doing so means they might not get paid on time.

Additionally, the fewer systems you use, the lower your likelihood of errors will be. Using a combined time tracking and payroll system like Buddy Punch will help you avoid errors caused by manual calculations or transferring data between multiple systems.

Using Buddy Punch’s direct deposit payroll software

Buddy Punch payroll’s features include tax filing, direct deposits, and compliance support, making payroll processing smoother and more efficient.

To set up Buddy Punch payroll, you start by setting up your company in Buddy Punch. You can create workspaces for different locations or for remote employees, and you can set up benefits deductions for things like insurance, HSAs, child support, and retirement contributions.

An address must be entered for each new employee you create. This lets the system know what federal, state, and local taxes need to be withheld from the employee’s paycheck.

Contractors can also be paid using Buddy Punch. When you create a new employee profile, simply select whether they’re a W-2 employee or a 1099 contractor. This lets Buddy Punch know not to remove taxes or other benefits from contractors’ payments.

Once the company is set up and employee profiles are created, employees can set up their accounts. They can enter their bank details to set up direct deposit of their paychecks, and they can also review their paystubs in Buddy Punch anytime.

Finally, you can choose two-day or four-day payroll processing. If you choose two-day processing and want your employees paid on a Friday, then you will submit your payroll no later than two days prior (i.e. the end of the day on Tuesday).

Direct deposit FAQs

Still have questions about setting up direct deposit for your employees? Below, you’ll find answers to some of the most common questions employers have.

Can you charge employees for direct deposit?

Employers are not allowed to charge employees for direct deposit. According to the Fair Labor Standards Act (FLSA), employers cannot deduct wages or charge employees for payroll-related services that are primarily for the benefit of the employer. 

Since direct deposit is typically seen as a method for employers to facilitate timely and accurate payroll processing, you cannot pass the cost of this service onto employees.

Additionally, in many states, any deduction from wages (including fees for services like direct deposit) is prohibited unless it is explicitly authorized by law or the employee. Check with an employment attorney to learn more about the laws in the states where your business operates.

Can an employer require direct deposit?

In some circumstances, employers can require direct deposit for employee pay, but it depends on the employment agreement and state-specific labor laws. While there are no federal laws that prohibit you from requiring direct deposit, some states, like California and New York, have rules that limit how and when an employer can mandate direct deposit.

What options are there for employees who don’t have bank accounts?

If an employee on your team doesn’t have a bank account, you can’t pay them through direct deposit. However, most payroll providers offer other options to use in this situation. Some allow you to pay employees by paper check in addition to direct deposit, and some will let you issue a prepaid debit card (i.e., payroll card) to employees that you add their wages to each pay period.

How long does it take to set up direct deposit?

From start to finish, setting up direct deposit for employees usually takes about 1-2 weeks, factoring in time for employees to submit their banking details, employers to enter their information into the payroll system, and the payroll provider to complete the verification process.

Related Reading:

• How to Calculate Payroll: A Guide for Beginners
• How to Calculate Wages + Free Paycheck Calculator
• 10 Tips for Managing Payroll for Small Business Owners