What is a Paycheck Advance and How Does it Work? [2021 Update]

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Financial emergencies arise in all of our lives. From an unexpected medical payment to an auto emergency, if you’re unprepared for these “surprises,” they can be stressful.

When someone is short on cash, they have limited options to turn to for assistance. According to the American Management Association, only 17% of Americans can turn to a family member or friend for financial assistance. The options available for the remaining 83% employees are glum. Credit cards, personal loans, or an employer’s aid are three of the only places to turn for instant financing.

Having quick access to pay before the payday (some call it employee cash advance) can enable employees to manage an unexpected emergency, which reduces stress and anxiety for those in these situations. Overall, it can also reduce financial problems that result from inflexibility in pay dates.

What’s the difference between employee loans and paycheck advances?

A payday loan is typically a sum of money that will be paid back in the future, under pre-determined terms. A paycheck advance is paying an employee their already earned pay, slightly before payday.

A loan is not guaranteed to be recouped. Your staff member might not make loan payments on time, or worse, not pay the loan back at all. And if they don’t pay it back, how large of an impact will it have on your business?

A paycheck advance offers access to earned pay, making it a less risky proposition. Still, there are important considerations to address.

What to consider before offering a paycheck advance benefit to your employees

First, ask yourself a couple of questions:

  1. Do you have a written payroll advance policy?
  2. Do you understand the tax implications?

Even a kindhearted decision to loan your employee money can have negative implications if not managed properly. It’s all too simple to be in violation of certain labor laws and tax codes. It can also be a burden on your payroll department depending on the volume of requests.

The IRS generally expects a lender to recognize interest income for advances, and the employer may be subject to taxes on that income, even if they did not charge any interest on the advance.

Additionally, employers need to be careful if they do charge interest on the advance – you cannot charge an amount that would drop your employee’s pay below minimum federal wage laws. There are also laws that state an employer cannot profit from a payroll advance.

If you decide to offer payroll advances, you should also set firm parameters defining what an employee can expect from you. Who is eligible, and what the terms of the advance are. How frequently will you give paycheck advances?

For information on the differences between a paycheck advance and on-demand pay, listen to APA Webinar Sponsored by DailyPay: Q&A #1 – On-Demand Pay Basics” or read the highlights of the session.


Weighing the pros and the cons of a paycheck advance

Taking a stand to alleviate an employee’s financial issues has its benefits. It is proven that being empathetic to hardships your employees face may improve employee retention and reduce turnover.

Financial distress leads to increased absenteeism, due to its effect on workers’ physical and mental health. And money was cited as the largest source of stress among respondents to a recent American Psychological Association survey, with nearly three-quarters of respondents noting that their stress level has increased or stayed the same over the past five years.

Historically, paycheck advances have been common in the workplace. However, times are changing. In a recent Society for Human Resource Management survey 2015 Employee Benefits: A Research Report that addressed the historic accessibility of paycheck advances in the workplace, modern workforces are gradually doing away with the perk. Between 2011 and 2013, payroll advances by companies decreased from 21% to just 13%, potentially from the convolution associated with administering them.

But, if an employer doesn’t offer the opportunity for an advance or an employee loan, where do employees turn for extra cash? Unfortunately, payday loans might be the next in line.

How much do payday loans cost?

Payday loans often make sense for someone who has no other option. Even credit cards can be difficult to land or rely on if financial hardships are commonplace, and someone’s credit score has faltered as a result.  

A payday advance from a financial institution typically comes with terms of a small-dollar amount short-term commitment. For this small amount – perhaps to pay a bill in an attempt to avoid late fees, come with interest rates hovering around the 300-400% rate.

Taking a stake in an employee’s financial wellbeing is important. And, understanding that these loans cost an exorbitant amount of money, might encourage you to lend a helping hand. Is a paycheck advance the best solution?

A modern paycheck advance

DailyPay is a non-disruptive payment application that allows your employees to be paid their earned pay, instantly, and without sorting through the tax implications or detailed parameters of a more “traditional” paycheck advance. With DailyPay you can issue even off-cycle payroll payments instantly. DailyPay is an easier alternative to paycheck advances.  And instant payment helps more than just employees. It benefits companies as well. When employees find financial security at a job, they stay longer. This results in measurably reduced turnover cost which allows companies to be more competitive in all areas of their business.

Want to learn more about how DailyPay can help you reduce turnover?