Pay discrepancies are incredibly frustrating. For employees, it means you aren’t getting the pay you deserve. It might mean hours of hard work aren’t compensated. And for employers, it means you made an accounting mistake. Retroactive pay addresses issues like these by correcting payroll errors. This ensures employees are paid what they’re rightfully owed.
Retroactive pay can address salary adjustments, unpaid wages, corrections, and more. Here’s a complete walkthrough about what retroactive pay is and when to use it.
What Is Retroactive Pay?
Retroactive pay, or “retro pay,” is simpler than it sounds. It’s money added to an employee’s paycheck to fix an earlier underpayment. It appears as a line item on a pay stub.
Retro pay fixes gets employees what they’re owed. These can include missed pay raises, uncounted overtime, and forgotten shift bonuses. It could happen because of an oversight. It could also involve more complex issues, including late promotions.
For example, if an employee gets a mid-month raise but the payroll system doesn’t update in the middle of the pay period, you have a problem. Retro pay adds the difference to the next paycheck to fix this.
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When Should You Use Retroactive Pay?
Businesses use retroactive pay in many ways. To ensure everyone is fairly compensated in different ways, these can include:
- Accounting or Payroll errors. Sometimes, payroll systems just make mistakes. This can include paying employees at old rates. For example, if an employee gets a raise starting mid-month, but the system is still using the old rate, retro pay can cover the difference.
- Unaccounted Bonuses or Commissions. Sales commissions or performance bonuses may be calculated incorrectly or not paid on time.
- Mistakes in Overtime Calculations. When employees work overtime, they’re owed time and a half. You can issue this pay retroactively to make up the difference if calculations are missed or incorrect.
- Incorrect Quotes. If a contractor issues a quote for their work but the final result goes over that amount, retro pay can cover the difference. This is useful when the estimate doesn’t match the actual work done or the scope of the project increases.
Retroactive pay is significant because it keeps employees happy and the business compliant with labor laws. Accurate retro pay calculations prevent delayed payments and legal issues. Once these mistakes are fixed, companies and employees know fair pay practices are in place.
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Back Pay versus Retroactive Pay: What’s the Difference?
It’s essential to understand the difference between back pay and retroactive pay. Both terms relate to correcting payment discrepancies, but they address different issues.
As explained, retroactive pay, or “retro pay,” is used when employees are paid less than they should have been. This comes from delays in pay raises, payroll errors, or other minor mistakes.
Back pay is for more severe situations involving when the employee wasn’t paid at all for the work they performed.
For example, if an employee wasn’t paid for overtime hours, the employer would owe retroactive pay. But, if an employee didn’t receive a paycheck for a pay period, they’re entitled to back pay for that time.
Retroactive Pay: Pros and Cons
Although retroactive pay isn’t optional, issuing it has both pros and cons.
Pros
- Corrects Payroll Mistakes. Retroactive pay helps employees receive missing compensation.
- Legal Compliance. It helps businesses comply with employment law and avoid possible penalties for unpaid wages.
- Employee Satisfaction. Correcting pay discrepancies boosts morale and ensures fair compensation. When employees see that their employer promptly fixes mistakes, it builds trust and satisfaction.
Cons
- Complex Calculations. Retro pay requires precise retroactive pay calculations to avoid further errors. For example, calculating the correct overtime rate if it was paid incorrectly can be tricky and time-consuming. You need to review the pay period and overtime worked to make sure there isn’t another mistake on the next pay stub.
- Delayed Payment Issues. Your business may have temporary financial strain following lump-sum payments. Paying unexpected large sums at once, like a retroactive raise or bonus, can impact cash flow.
- Administrative Burden. Calculating retroactive pay increases the workload for payroll and accounting departments.
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How to Calculate Retroactive Pay
Accurate retroactive pay calculations are essential to ensure employees get the correct compensation. Here’s how to do it.
1. Identify the Pay Error
Determine the kind of pay error you’re dealing with. Was it a missed raise, an overtime miscalculation, a bad estimate, or a payroll error?
2. Gather Information
For hourly employees. Find the old hourly rate, new hourly rate, effective date, and the total hours worked at the old rate.
For salaried employees. Find the old annual salary, new annual salary, effective date, and the number of affected pay periods.
3. Calculate the Difference
For hourly employees. Subtract the old rate from the new rate and multiply by the total hours worked. For example, if Sarah’s hourly rate increased from $13 to $14 and she worked 160 hours at the old rate, her retro pay is $1 per hour times 160 hours, totaling $160.
For salaried employees. Calculate the old and new salary for each pay period and find the difference. For example, let’s say Mike’s salary increased from $55,000 to $57,750 annually. That means his gross semi-monthly pay increases to $2291.66 to $2406.25. But it wasn’t updated in the system. His first payday after the raise, he received the old amount. His retro pay to cover that semi-monthly period would be $114.25 (before taxes and deductions).
4. Add to Next Paycheck
Once you know the missing figure, you include the retro pay amount in the next paycheck as miscellaneous income.
5. Ensure Compliance
Apply all required payroll taxes to the retro pay amount.
Retroactive Unemployment Pay
Retroactive unemployment pay is what it sounds like. You get money for past weeks when you should have received unemployment benefits but didn’t. This ensures payment for the time you were out of work.
If your unemployment claim is delayed, retroactive unemployment pay will cover missed payments. This helps people who need unemployment benefits for living expenses and makes sure they get the money they deserve.
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Avoid Retroactive Pay by Issuing Accurate Invoices with Joist
Retroactive pay is simply about ensuring fair compensation. And payment accuracy is crucial with your clients, too.
With the right invoicing software, you don’t have to worry about common invoicing mistakes. Joist can help you issue professional, customized invoices so you don’t miss a detail. Plus, it tracks all payment history, so you always have a record of payments made.