How Does Direct Deposit Work?

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Direct deposit offers people a quick and easy way to receive compensation from their employers. It's standard practice these days, and businesses typically offer it as a standard service to employees. It is helpful to understand exactly what it is, how it works, and how many applications it has.

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What is Direct Deposit?

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Direct deposit is when money is deposited automatically and electronically into a bank account on a regular basis by an employer. This payment method replaces paper checks, and it uses an electronic network to complete each transaction called ACH (Automated Clearing House).

Direct deposits are transferred electronically, and the funds are credited to recipients' accounts instantly. It is convenient for both the payer and the payee! More automation, less manual check writing - yes please!

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Direct Deposit vs. Paper Check Payments

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Direct deposits are a better alternative to paper checks for several reasons.

There is a degree of risk involved with issuing and using paper checks. They can easily be lost or stolen, and it is fairly simple for someone to fraudulently cash a check if they get their hands on it.

Even though paper checks can be replaced if any of the above occurs, the process can be a long and painful one for employer and employee. You may have to pay a fee to get a new check issued, and getting a stop payment on a stolen check can be an annoyance.

These are issues that never arise with direct deposit as long as it is set up correctly. Funds are securely deposited and there is no need to worry that the money will get lost or stolen once it has been sent to a person's bank account. And best of all... it's fast! Deposit deposit ensures you get your money is in your account on time, every time.

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How Does Direct Deposit Work?

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Even though there are many applications for direct deposit, most people are used to having it set up by their employers.

The first step is for the employer to collect the employee's bank account information, including their bank account number and their bank's routing number. If you haven't done this yet, ask your HR representative so that they can get the process going.

Prior to payday, the employer sends payroll instructions to the company's bank. That information is then used to trigger an ACH for the amount owed, placed directly into your account.

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Other Than Employers, Who Offers Direct Deposit?

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Most people associate direct deposit with corporate payroll, but it also has many other applications. Here are a couple other ways to utilize direct deposit:

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Independent Contractors

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Even though most independent contractors get paid by check, in cash, or using some other electronic payment method, direct deposit is available for them too.

Businesses can make arrangements to pay independent contractors through direct deposits, and even if the amount they owe changes, their payments can be sent electronically on a schedule they choose.

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Child Support Recipients

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Most parents who receive child support will receive a notice from their state to set up direct deposit. There may be other options available too, including using a special prepaid debit card that is issued just for that purpose.

But getting child support through direct deposit is typically easier, and parents will have access to those funds much faster than if they wait for a paper check to arrive in the mail.

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Social Security Benefits

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In 2013, all benefits paid by the Social Security Administration are available only by direct deposit. When this change was made, it resulted in a savings of around $120 million per year.

Unfortunately, not everyone who receives social security benefits has a bank account for direct deposit payments. But in those cases, those funds are made available to individuals on a prepaid debit card.

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Tax Refunds

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The fastest way to receive a tax refund is to set up direct deposit with the IRS after filing your tax return electronically. Most taxpayers that have done both of these things will receive their tax refunds in as little as 21 days.

Paper checks take a lot longer, and with direct deposit, you can choose to have money sent to up to three different bank accounts, if you choose.

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Military Pay and Veteran Benefits

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Members of the military can set up direct deposit through a web portal that records their banking information. This is beneficial for them; especially when they need to spend time overseas or they are stationed far away from home.

Disability compensation and Veterans Affairs healthcare benefits are also paid out through direct deposit.

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Unemployment Benefits

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When applying for unemployment benefits, you will get access to your funds much faster if you have direct deposit.

Most states highly recommend direct deposit for unemployment benefits. It's much more cost-effective, and there is no concern that checks will get lost or stolen and need to be replaced.

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Insurance Benefit Payments

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There are several types of insurance benefits that get paid out through direct deposit, such as:

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• Life insurance and death benefits
• Disability insurance
• Homeowners insurance
• Renters insurance
• Car insurance

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Opting for direct deposits with any of the above gives people access to the money they are owed much faster than if they had to wait for a check to arrive.

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Pros and Cons of Direct Deposit

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Although there are mostly benefits to having direct deposit in place, it does have a few drawbacks.

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Pros:

• It is much more convenient
• You'll have faster access to your funds because they're available immediately
• You'll help your employer save money and resources
• You will receive digital records instead of paper records
• Your bank may wave monthly fees if you have direct deposit in place

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Cons:

• There is an increased risk of online security hacks
• You'll need to provide your banking information, and not everyone is comfortable with that

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The pros far outweigh the cons in this instance, and for most people, the benefits of having direct deposit are very clear.

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Should People Switch to Direct Deposit?

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Whenever possible, most people should make the switch to direct deposit if they have gotten used to receiving paper checks as payment.

Switching is generally quick and easy, and it offers all the benefits listed above.

Keep in mind that if you do choose to switch, the changes might not take effect immediately. For example, if you made the change with your employer, you may have to wait one full pay period for them to pay you electronically versus sending you a paper check.

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How do You Set Up Direct Deposit?

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Setting up direct deposit is a straightforward process. If you're setting it up with your employer, they probably have a direct deposit form they will ask you to fill out. On that form, you'll need to provide details like:

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• Your name as it appears on your bank account(s)
• Your address
• The name of your financial institution
• Your bank's address (though often not needed)
• Your bank account number
• Your bank routing number
• The type(s) of account(s) you want your money transferred to
• How much of your paycheck you would like deposited

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Please keep in mind that you are not limited to just one bank account. You can direct your direct deposit funds to go to:

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• Multiple financial institutions
• Your savings account
• Your checking account, or multiple checking accounts

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In some cases, you may have to include a voided check with your direct deposit form as well. If you want your funds to go to more than one account, you'll need to include a voided check for each one.

You may have to include a savings deposit slip if you want some or a portion of your electronic payment to go into a savings account.

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How Fast are Direct Deposit Payments?

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Electronic payments may take up to four business days, but most employers have a schedule in place so that their employees always receive funds on the correct payment date. Timely payment is important.

Payments made from a government institution like the military or the Social Security Administration are made on a revolving schedule. In many cases, money transfers take place instantaneously, and may even be available in the payee's account before the scheduled time.

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Using Direct Deposit to Send Payments

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ACH payments can also be used to send electronic payments. Some people choose to set up online bill payments instead of sending a physical check in the mail to pay bills.

The best way to set this up is to work directly with the company you owe money to. You can coordinate with them to make sure that all digital payments are sent on or around the day you get paid.

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Direct Deposit for Employers

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Most employers will directly benefit from offering direct deposit to their employees. While there are costs involved with setting this service up initially, those costs are offset by the money saved over time.

Other benefits include:

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• Fewer bank visits are required
• A more efficient payroll process
• Less chance of check fraud
• Streamlined payroll checks
• Electronic records and reporting

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Alternatives to Direct Deposit

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If you are going to have direct deposit in place, you'll need to have an account with a bank or a credit union.

Not everyone has bank account information to provide, so in those cases, your employer or another payer might be willing to offer you a different option instead of insisting on using direct deposit. Some of those options are:

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• Issuing you a prepaid debit card
• Paying you via Venmo
• Paying you via PayPal
• Paying you via CashApp

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There are many electronic services available that an employer or entity may be able to use for your payments. But most people find that not only are they not as convenient, but they charge high fees that eat into your paychecks.

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Final Words

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We highly recommend setting up direct deposit, whether you need it for your regular paychecks, government benefits, or to receive your tax refunds.

It's easy to access your account information online, and we're confident that you'll find direct deposit to be much more convenient and helpful for your personal finance planning.

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