What Is Retro Pay?

What is retro pay?

Retro pay, short for retroactive pay, is money paid to an employee when they were undercompensated during a prior pay period. Retro pay compensates the employee for the difference between what they should have been paid and what they received. Retro pay should be calculated and included in the employee’s next paycheck.

Retro pay is relatively uncommon for small businesses, and conducting regular payroll audits can reduce the likelihood of inaccuracies. However, when it does happen, it should be communicated to the employee immediately and fixed promptly. 

“When possible, it’s best to first let the employee know in person when a pay error has been made,” said Karen Oakey, head of people at Soda Health. “Then, follow up with an email. Take the personal approach first and see if there are any immediate questions.”

When do employers pay retro pay?

Here are a few common reasons why an employer would need to retroactively pay an employee.

Pay raises

If an employee is given a pay raise, the new salary might not be entered into the payroll system in time. For example, if payroll is underway when the new salary is agreed upon, the changes cannot be applied until the next pay period. However, an organization’s accounting team can easily apply the employee’s raise retroactively for the next pay period and beyond.

Additionally, there are some instances where a pay raise may be retroactive. For example, if an employee is due to receive an annual pay increase on July 1 but the amount of the raise isn’t determined until August, the increase they should have received might be retroactive to July 1.

Miscalculated earnings

There’s always a chance that mistakes can happen. An employee’s pay rate or total number of hours worked could be entered incorrectly, resulting in the wrong amount paid. As such, employees should always check their pay stubs to make sure they receive the correct amount.

Commissions

Some employees, particularly those who work in sales, earn commissions based on meeting or exceeding specific goals. For example, if an employee exceeds target sales numbers for a quarter, they may be entitled to additional income. However, if commissions are not calculated automatically, they could be missed.

Shift differentials

If an employee works a different shift that pays a different hourly rate or the employee works overtime, that change in pay type may get missed. Shift differentials occur when an employee is paid at a higher rate to work outside their normal business hours, such as a graveyard shift. For overtime, when an employee works more than 40 hours in a week, they are paid 1.5 times their hourly rate, and that rate change might be missed.

Multiple pay rates

Some organizations have different pay rates depending on the job the worker is doing. If an employee has two or more positions within the organization and earns different pay rates for them, the wrong rate may be submitted.

Bonuses

Similar to commissions, an employee can earn a bonus during a pay period, but it may take a few pay cycles for it to be recorded in the accounting system.

Back pay vs. retro pay

Back pay is similar to retro pay, and they are often confused. However, there are some distinctions.

Back pay

Back pay is given to an employee when they were not compensated for their work during a prior pay period. In contrast to retro pay, back pay is for wages that were altogether missed and never paid to the employee. To issue back pay to a worker, you can either run a separate payroll check or include the missing wages in their next paycheck.

Retro pay

Retro pay is when an employer makes up the difference, or shortfall, between wages the employee should have been paid versus the amount the employee received during the pay period. Retro pay corrects underpayment resulting from payroll mistakes and miscalculations, whereas back pay compensates an employee for completely missed wages.

How to calculate retro pay

The process of calculating retro pay differs depending on whether the staff member is an hourly or salaried employee.

Hourly employees

When you’re determining retro pay for an hourly employee, first you need to identify the error. Once you know the correct rate and the right number of hours the employee worked, multiply the differential rate by the hours paid and calculate the gross retroactive pay amount.

Because retroactive payments go on the employee’s next paycheck, remember to add the amount owed in retro pay to the amount they are owed for the current pay period. If the total number of hours exceeds 40, you’ll have to decide how to make the payment; overtime payment may be needed.

Salaried employees

Because salaried employees don’t have a set rate, it can be tricky to determine their retro pay. First, calculate the difference between the annual salary they were paid and the salary they should have been paid. Then, verify the number of bill days in the year to get the accurate rate.

Calculating retro pay can be complicated, especially for salaried employees. Use payroll software or a free online paycheck calculator to ensure accurate calculations. [Read related article: Don’t Want to Cut Employees? Try Cutting Salaries]

How does retro pay affect taxes?

Even though it is a correction to a previous paycheck, any retroactive payment must be taxed. Wages from retro pay are subject to the same rates as an employee’s regular wages. 

As retro pay is a type of supplemental pay, you should use the percentage or aggregate method to withhold federal income tax from that supplemental wage. You’ll also need to withhold FICA tax (Social Security and Medicare) and, when applicable, state and local income tax.

Companies should consult their state government about how to calculate state and local income taxes on retro pay. If you issue a separate check instead of adding the retro pay to the employee’s next paycheck, that payment is still subject to the same taxes.

The best payroll software 

Using high-quality payroll software helps prevent errors that lead to owed retro pay and ensures that retro payments are awarded correctly. It can also reduce the time you spend on payroll so you can focus on other aspects of your business.

Here are some payroll software options to consider:

• ADP: ADP offers multiple options for payroll services and HR plans. It’s a popular choice for growing businesses because it can scale as your company expands. This software can automate your payroll and manage your tax filing process, and employees can access their tax forms and pay stubs from the mobile app. [See our ADP Payroll review.]
• Gusto: Gusto allows you to blend its features into your current systems, thanks to integrations with over 20 time-tracking applications and dozens of hiring and performance platforms. Along with a full suite of payroll and HR solutions, Gusto provides customizable templates for offer letters and a checklist to streamline hiring and onboarding. [See our Gusto Payroll review.]
• isolved: With isolved, customizable modules allow you to choose the services and tools your business needs. Options include payroll processing, benefits administration, learning management platforms, scheduling and more. [See our isolved Payroll review.]
• Intuit QuickBooks: With features such as same-day and next-day direct deposits, Intuit QuickBooks syncs with QuickBooks Online to offer integrated accounting and payroll solutions. With this integration, you can easily update employee wages and benefits. [See our QuickBooks Payroll review.]
• OnPay: Onboarding specialists are available to help you set up this payroll software. Unlike some other software options, OnPay does not charge extra to process payroll for employees in multiple states or to create customized payroll reports. [See our OnPay Payroll review.]
• Rippling: This payroll software offers multiple options for automating processes beyond payroll and tax filing. Rippling’s workflow builder integrates with hundreds of third-party systems to automate a wide variety of common HR tasks and workflows. [See our Rippling Payroll review.]

Sean Peek contributed to this article. Source interviews were conducted for a previous version.