Paid in Arrears: What Does it Mean for You & Your Business

When employees get paid is important to everyone at your business. It’s important to employees because it determines when they should expect their wages and how they should budget their funds.

It’s important to employers for the same reason—it influences cash flow and budgets for the business. That is why it’s essential to understand the basics of common payroll schedules and related terminology, like payroll in arrears.

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What Does It Mean to Be Paid in Arrears?

Paid in arrears is a payment term in which the employee is compensated after they work for a period of time and agree to be paid after the period of time ends. Most businesses use arrears payments in order to make running payroll easier. The opposite of paying in arrears would be upfront or an advance payment before work is complete.

Arrears literally means, “an unpaid and overdue debt,” meaning past its due date. But when people talk about payroll in arrears, they are referring to the fact that employees may have a pay date that is after their pay period has ended.
So while the employer does owe the employee money for their time worked, payroll in arrears is legal (with some reasonable restrictions), and in fact, often the expectation for hourly employees.

States determine acceptable payroll schedules for employees. Typically this is done by employee type. So salaried employees will have one set of rules, and hourly employees will have another set of rules

Different Payment Schedules

For example, in California some salaried employees can be paid on a monthly schedule, while hourly employees must be paid at least twice a month. Additionally, employees on a weekly or biweekly pay schedule must be paid within seven calendar days of the end of the pay period.

They also have more specifications for certain industries, like the motion picture industry. These state rules exist to protect employees and ensure they are paid in a timely fashion after completing work for a business.

Before you select a pay schedule for your business, it is important to check any applicable laws in your state.

Paid in Arrears Example

Let’s say an employee works for a company that pays its employees on a monthly basis and in arrears. If they start working for the company on April 1st, they would work the entire month of April, but they wouldn’t receive their first paycheck until May 1st.

This is because the payment for April is made in arrears, after the work has been completed. From then on, they would continue to be paid on the 1st of every month for the work they completed in the previous month.

Benefits of Paying in Arrears

Paying in arrears can provide quite a few benefits for employers.

Better Cash Flow Management

Paying in arrears helps you manage cash flow more effectively by delaying payment until work is completed and payment has been received from your clients.

Encourages Hard Work

Payment in arrears encourages employees to work hard and complete their tasks on time, since they know their pay depends on it.

Better Payroll Management

Arrears payment provides you with greater control over payroll, since you can review completed work before releasing payment.

Accurate Payment

Payment in arrears ensures that employees are paid accurately and fairly, since you can verify completed work before payment is made.

Reduces Overpayment Risk

It can reduce the risk of overpayment or payment for incomplete or subpar work, as payment is withheld until the work is completed to the required standard.

Disadvantages of Payment in Arrears

Can Create Financial Strain for Employees

Payment in arrears can cause financial difficulties for employees who rely on regular, immediate payment to cover expenses like rent or bills. Waiting for payment can cause anxiety or stress for some employees who are living paycheck to paycheck.

Decreased Motivation and Engagement

If employees feel that they aren’t being compensated fairly or in a timely manner, it can lead to decreased motivation and engagement. For instance, if employees feel that they are being paid less than their peers or are not receiving payment on time, they may become less motivated to work hard or complete tasks on time.

Potential Administrative Challenges

Payment in arrears can create administrative challenges for employers, particularly if they have a large workforce. Employers must accurately track hours worked and tasks completed to ensure that employees are paid accurately and fairly.

This can be time-consuming and complex, particularly if there are changes to pay rates, taxes, or other factors that affect payment.

Common Types of Payroll Schedules

There are three common payroll schedules: weekly, biweekly, and semi-monthly. It’s also possible to pay some workers monthly in some areas, but this isn’t as common as the other three types of schedule.

1. Weekly

Weekly payroll means a pay date happens once a week, for a total of 52 pay dates in the year. The pay period for a weekly schedule is a week-long, often Saturday to Friday, you can choose the best period that works for you. Employees benefit significantly from a weekly pay schedule. It offers them a consistent and predictable income stream, which aids in better financial management and reduces the likelihood of experiencing financial difficulties throughout the month. For employers, the main advantage lies in the ease of calculating payroll, as the consistent weekly schedule simplifies this process.

However, this schedule is not without its drawbacks. For employers, processing payroll every week can be time-consuming and incur higher costs. Additionally, there’s the challenge of calculating deductions like health insurance premiums more frequently.

2. Biweekly

Biweekly payroll means a pay day happens every other week, for a total of 26 pay dates in the year. The pay period for a biweekly schedule is two weeks long, and you can choose the days that work best for your business. With a biweekly pay schedule, employees enjoy predictable income and the ease of budgeting that comes with receiving paychecks on a regular schedule. This frequency strikes a balance between regular income and manageable payroll processing.

From an employer’s perspective, a biweekly schedule reduces the administrative burden compared to weekly payroll. It also simplifies the calculation of overtime for hourly workers, making it a practical choice for many businesses.

The downside for employees is the longer interval between paychecks, which can be challenging for those who depend on regular income. For employers, biweekly pay can involve more paperwork and a higher potential for errors compared to monthly pay schedules. There’s also the slightly increased cost due to more frequent payroll processing.

3. Semi-monthly

Semi-monthly payroll means a pay date happens twice a month, for a total of 24 pay dates in the year. The pay period for a semi-monthly schedule is typically the 1st to the 15th of the month and the 16th to the last day of the month. Pay days are usually on the 15th and last day of the month.

Since some months are longer than others, the exact number of days in the pay period can change with a semi-monthly pay schedule.

A semi-monthly pay schedule offers employees more frequent payments than a monthly schedule, aiding in more effective financial management. It allows for better budgeting due to the regularity of income.

For employers, this schedule helps manage cash flow more evenly throughout the month and can potentially reduce overtime expenses. It’s also generally easier for accounting purposes compared to a weekly or biweekly schedule.

However, for employees, the variable payday in terms of the week’s day can be inconvenient. Employers face the challenge of managing a more complex payroll due to the varying number of days in each pay period.

Why do Companies Pay in Arrears?

Companies may choose to pay in arrears for a few reasons. Firstly, paying in arrears can help manage cash flow more effectively. By delaying payment until work is completed and payment has been received from clients, companies can avoid overextending themselves financially.

Paying in arrears can also provide an incentive for employees to complete their work on time and to a high standard. If employees know that their pay depends on completing their work on time and to a certain standard, they may be more motivated to do so.

Paying in arrears can also help make sure employees are paid accurately and fairly. You have the opportunity to review completed work before releasing payment, which can reduce the risk of overpayment or payment for incomplete or subpar work.

Payroll in Arrears FAQs:

What is the Benefit of Paying in Arrears?

The benefit of paying arrears is that a business will pay employees what they are owed for already completed work. Many small business owners choose this method of payroll because it gives them time to run payroll and time to factor in calculations like tips, PTO, or overtime.

Do Most Companies Pay in Arrears?

Yes, most companies pay in arrears, especially those with hourly or tipped employees. Since employees’ hours can change workweek to workweek, it will take payroll a few days to be finalized.

How Does Paying in Arrears Affect Employees?

The biggest effect this type of payment system has on employees is the lapse between work and pay. A current pay system means employees are paid immediately, while arrears has a lag of at least a few days. This might seem like a late payment but many businesses use this payroll method and it is actually very common. Employees are paid their agreed-upon wage and it gives businesses time to run payroll.

How Does Payment in Arrears Impact Health Insurance Benefits?

Payment in arrears can lead to a situation where an employee’s paycheck might not cover voluntary deductions like health insurance premiums. This shortfall, known as benefit arrearage, requires the employee to pay the unpaid amounts towards their benefits. If not managed correctly, this can result in the loss of health insurance coverage. Insurers typically offer a 90-day grace period to make up missed premium payments. Failing to pay the full outstanding amount by the end of this period could lead to the termination of coverage.

What Effect Does Payment in Arrears Have on Retirement Plan Contributions?

When it comes to retirement plan contributions, payment in arrears usually includes the pro-rated amount of the final month’s retirement pay. Retirement pay entitlement ends on the retiree’s date of death, and the arrears of pay encompass all due amounts. This means that any unpaid retirement benefits up to the date of death will be included in the final payment.

How Are Tax Deductions Affected by Payment in Arrears?

The timing and amount of tax deductions can be influenced by payment in arrears. When employees are paid in arrears, tax deductions are calculated based on the actual income received during a specific period. This differs from calculations based on estimated earnings, potentially affecting the total amount of taxes deducted from each paycheck.

Can Other Payroll Deductions Be Impacted by Payment in Arrears?

Yes, other payroll deductions, such as child support payments, can be impacted by payment in arrears. If child support is paid in advance, the household qualifies for a child support deduction. However, if these payments are made in arrears, it might alter the applicable deductions. This change is due to the timing of the payment in relation to the payroll period.