- Retro pay is the difference between what you paid employees last pay period and what you actually owed them.
- You can issue retro pay via separate paychecks or, more commonly, as miscellaneous income in the employee's next regular paycheck.
- Payroll software can help you calculate and issue retro pay, while minimizing the issues that lead to retro pay in the first place.
- This article is for employers looking to understand retro pay and the process of making up for accidental gaps in employee pay.
When business processes involve large numbers of calculations, mistakes are inevitable. As payroll goes, these errors can lead to paychecks being smaller than they should be, and you'll have to make up the gap with retro pay. Although calculating how much you owe isn't that tough, it's certainly easier with payroll software, which also minimizes the need for retro pay in the first place. Learn more below.
What is retro pay?
Retro pay describes any extra wages added to employee paychecks when a previous paycheck was less than the amount you actually owed. It's important to issue retro pay as quickly as possible to remain compliant with wage and labor laws.
Retro pay isn't quite the same thing as back pay, which we'll explain in more detail later.
When is retro pay usually applied?
Retro pay typically stems from modest errors found after processing payroll that can be corrected easily. These errors include:
- Salary raises. Let's say you pay your employees bimonthly on the 15th and 30th of the month. Let's also say you give an employee a raise on the 8th. In some cases, your payroll processing system might be unable to implement this increase until after the next payday, on the 16th. That's a week of wages paid at an incorrect rate. With retro pay, you can make up for this difference in the employee's next paycheck.
- Bonuses. A bonus or merit pay increase earned in one pay period isn't always applied to that period's paychecks. In some cases, you won't be able to add that bonus to the employee's paycheck until the next period. Technically, doing so is a form of retro pay.
- Commissions. With commissions, the delay may stem from clients instead of you. As an example, let's say that 10 days before your pay period, an employee secures a sale from which they take a 5% commission. However, you can't cover that commission until the client pays. If they submit payment after the pay period, then you'll retroactively pay your employee their share. Learn more about creating compensation plans.
- Overtime. In theory, overtime should be paid during the same period in which it's earned. However, if you accidentally record your employees' overtime hours as regular hours, you'll need to pay the employee their increased overtime wages retroactively. This instance of retro pay requires swift action, as employees may view having their overtime pay withheld as wage theft.
- Shift differentials. When employees earn shift differentials, you might forget to record these hours at their higher wages, as with the overtime example above. The same procedure should follow: To avoid accusations of wage theft – and its legal ramifications – you should issue retro pay as soon as possible.
- Incorrect timecards. Sometimes, employees may make errors on their time and attendance records. In this case, they will not be paid for hours or days that they did indeed work. The employee should report this discrepancy to you, and you should address it by retroactively paying them in their next paycheck.
Retroactive pay laws and payroll
In the above cases, your company shouldn't face legal troubles as long as you address the issue right away. Just acknowledge the issue with the employee, calculate the retro pay owed, add it to your employee's next paycheck and let them know. Verify with your employee that they've received their retro pay on your next payday, and you should be all set.
However, in other cases, certain laws apply.
The Fair Labor and Standards Act
Federal overtime rules, as outlined by the Fair Labor and Standards Act (FLSA), state that employees may pursue retro pay for unpaid minimum wages, overtime and wage increases. However, it doesn't provide much of a framework beyond that. It does, however, cap the time after an issue first arises during which an employee can pursue retro pay. This statute of limitations is two years. If you intentionally violated FLSA provisions, this period increases to three years.
Beyond retro pay, the FLSA requires that employees be paid no later than 12 days after a pay period ends. This provision comes into play if including retro pay in a regular paycheck would mean you're issuing it after this 12-day period. If so, you may need to issue retro pay through a separate paycheck rather than with the employee's next regular paycheck.
State retro pay laws
As retro pay goes, state laws mostly concern wage payments upon employee termination. In many states, you must immediately pay employees the wages earned between the previous pay period and their moment of termination. Other states give you a bit more time. Additionally, in some states, if you overpay rather than underpay an employee, you can't ask for that money back or withhold it from future paychecks. Consult an expert in your area to learn more.
How to calculate and pay out retro pay
Calculating retro pay looks slightly different based on whether you're doing so for an hourly or salaried employee. Either way, your choice of when and how to pay will hinge on the factors described above. If you pay retro wages in the employee's next regular paycheck, you should indicate the amount as miscellaneous income.
How to calculate hourly employee retro pay
To calculate an hourly employee's retro pay, determine how many hours you paid at the incorrect rate. Then subtract this incorrect rate from the proper rate. Multiply this difference by the number of improperly paid hours. The number that results is the employee's retroactive gross wages. Be sure to withhold taxes and other deductions from it when you pay it out.
How to calculate salaried employee retro pay
To calculate a salaried employee's retro pay, divide the employee's salary by your number of pay periods per year. For example, an employee who makes $60,000 with biweekly pay is paid 26 times per year. Their gross wage per paycheck is calculated as such:
$60,000 ÷ 26 = $2,307.69
Then look at how much the employee was actually paid. Let's use a wage raise as an example and say that the employee's $60,000 salary reflects a recent raise. However, in the last pay period, you used the employee's old $58,000 salary to calculate two weeks of pay. Per biweekly pay period, that's $2,230.76 in gross wages ($58,000 divided by 26). You thus owe the employee gross retro pay of $76.93 ($2,307.69 minus $2,230.76).
Regular pay vs. retro pay vs. back pay
You'll often see the terms "retro pay" and "back pay" used interchangeably. The latter term, though, has a harsher connotation and is more often used in situations requiring legal action. We'll break down these terms alongside "regular pay" below so you can understand the differences.
Regular pay
Regular pay is exactly what it sounds like. Anytime an employee receives a paycheck on their typical payday, that's regular pay. Any money missing from this paycheck is what you'll later issue as retro pay.
Retro pay
Retro pay, as explained earlier, is payments made after a pay period ends for wages accidentally not paid during that pay period. It can result from mistakenly using the wrong pay rate or number of hours worked.
Back pay
Back pay is a type of retro pay in which an employee is owed all their wages for a pay period after that period's payday. It's what employees demand when they aren't paid at all for a pay period.
Where retro pay often stems from accounting errors, back pay may have more sinister origins. In fact, the term "back pay" is often used to describe a court-ordered payment of wages owed to an employee. Courts may also require employers who owe back pay to double the amount to be paid. This fact should make it pretty clear why back pay is important to issue well before your employee threatens legal action.
Calculating back pay with payroll software
Whether you're issuing back pay or retro pay, the stress is similar: How can I assure the employee that I do intend to pay them? How can I ensure this won't happen again? How can I calculate retro pay correctly to nip this issue in the bud? That's where payroll software comes in.
Your payroll software will handle and automate all your wage calculation, payment and tax needs, and help you keep accurate paycheck records. All you have to do is ensure your payroll software has the correct numbers to work from. Then you can sit back and let it calculate and issue all your paychecks. These calculations include employee and employer payroll taxes, helping you comply with tax laws.
Payroll software comes in many varieties. OnPay, for example, is ideal for very small businesses given its low fees and untiered feature access. (Read our OnPay review for more information.) Paychex may be better for larger businesses with many employees, where it's more likely you'd make the tiny errors that necessitate retro pay in the first place. A payroll service like Paychex can help you avoid those mistakes.
Visit our best payroll service reviews to find the right fit for your company so that you can avoid making payroll errors and issuing retro pay – but if you do need to issue retro pay, that'll be easy too with payroll software.