How Does Direct Deposit Work?

Direct deposit is a type of bank transaction where funds are electronically transmitted from one account to another. Often used by businesses to pay employees, direct deposit requires the payee to provide bank account information, including account and routing numbers, to the payer in order to authorize access. In addition to employers, government agencies also use direct deposit for Social Security, retirement and unemployment.

How Does Direct Deposit Work?
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What Is Direct Deposit?

With direct deposit, a business signs up to have its bank automatically deposit payments into a specific account, whether at that branch or a completely different bank. Prior to direct deposit, employers had to print paper checks, which were then distributed to employees for them to deposit in the bank themselves. This means instead of waiting in line at the bank drive-thru with everyone else on Friday afternoon, employees see the money show up in their account.

Direct deposit goes beyond making life easier for employers and their workers. Financial institutions prefer direct deposit because it ensures a steady, predictable flow of money into their location. They also can enjoy the benefits of high account balances without having to employ extra tellers at their branches to manage all of the paychecks being deposited on a weekly basis.

How Does Direct Deposit Work?

There are multiple steps involved in transmitting an electronic payment, starting with the payer directing its bank to issue a payment on a specified date. The issuing bank then submits the request to the Automated Clearing House, which manages all of the electronic transactions for America's banks. Once approved, the payment then goes through the Federal Reserve, which directs the transaction to the payee's bank account.

Each bank has its own policy as to when ACH transactions are posted to accounts. The rule is that the money needs to be in the account no later than the opening of business on the date directed in the transaction. Weekends and bank holidays can affect this, so employers are directed to keep this in mind when setting up deposits for employees.

How to Set Up Direct Deposit

Setting up direct deposit for one worker isn't overly difficult. You'll simply need to get a Direct Deposit Authorization Form from your bank. The employee will provide an account number, routing number and other information, then sign the form. However, once you have multiple employees, things can get a little more complicated. You'll begin balancing multiple signups, along with checking to make sure your existing payments are going as planned.

To make things easier, some employers set up a sign-up portal. Through this, employees can offer their information and authorize deposits. Software can automate much of this process, collecting the information and passing it on to a database, with the information collected and transmitted to your financial institution. All of this can help save you money and reduce errors.

Things to Consider With Direct Deposit

If your employer offers the option of direct deposit, you may wonder if it's secure. It has been proven as a safe, confidential way to get funds from one account to another. When an employer gives you a paper check, you're responsible for getting it to the bank without losing it. If something happens before you make it to the bank, it will take time and expense on your employer's end to stop payment on the original check and issue a new one.

Like your employer, you should also keep in mind that weekends and holidays can affect turnaround time. Although direct deposit can give you the peace of mind of knowing your money will be in your account on the designated day, it can also be too easy to lose track of the many banking holidays that take place each year and assume you'll have money earlier than you will.