A direct deposit occurs when funds are electronically transferred out of one bank account and then deposited into another account.
In other words, this is one type of automated funds transfer, with direct deposits often used for payroll purposes, rather than having employees get paid via cash or through physical checks.
The concept of direct deposits can be traced back to 1968. That’s when bankers in California decided that technology might not be able to keep up with the number of paper checks being issued and cashed.
So, they created SCOPE, which is the Special Committee on Paperless Entries, to come up with a solution. The American Bankers Association sponsored a study around the same time to discover ways to improve the payment system in the United States.
In 1972, the first automated clearing house (ACH) network formed to manage electronic payments, with other networks quickly following. In 1975, the Social Security Administration (SSA) decided to test the system of direct deposit for payments they issued. Today, 99% of SSA’s payments are directly deposited.
The U.S. Air Force became the first employer to pay people through this method. And, today, nearly 93% of employed people in the United States receive their salaries or wages this way.
Automatic bank transfers are used today in ways beyond having paychecks directly deposited, including bill pay, retirement account contributions, and more.
Explaining Payroll Direct Deposits
Let’s say that someone is ready to start a new job. The human resources department explains how the company either requires direct deposit or offers the option.
If that employee signs up for direct deposit, they would need to share bank information with their new employer, including the bank’s name, the routing number that identifies the financial institution, and the employee’s bank account number.
This information would then be entered into the company’s payroll system and, whenever payroll rolls around, the company would send an electronic file to this employee’s financial institute. This file would share how much money should be transferred from the company’s (the “originator’s”) bank account to accounts for each of the employees whose direct deposit accounts are located at that particular financial institution.
If, for example, three employees of a company all share Bank A, then let’s say this bank receives an electronic transfer of $4,345. Bank A would then distribute the money appropriately into the proper bank accounts, perhaps:
• $2,000 in Person A’s checking account and $500 into their savings account
• $1,350 in Person B’s account
• $445 in Person C’s checking account and $50 into their savings account
Then, if the employees (known as “receivers”) check their bank balances, they’ll see the deposits made through this direct deposit process.
As noted in this example, money may be directly deposited to a checking account or into a savings account. Or, some money can be put into a savings account with the rest in a checking account.
In September 2016, same day transfers for direct deposits debuted.
Benefits of Payroll Direct Deposits
With a direct deposit of their paycheck, employees can skip the step of physically depositing a paycheck into their accounts, which can be a timesaver.
This can be especially true if the employee telecommutes from home, is on vacation, or is otherwise out of the office when payday comes, because that employee doesn’t have to go into the office to retrieve the paper check.
With direct deposit, the money is typically in an employee’s bank account at the start of the designated payment date, which gives them access to the funds that day.
With paper checks, there’s always the possibility that they will get lost or stolen. So, payroll direct deposit can add a layer of security to the process.
Many times banks will waive fees for customers who have direct deposits set up, although there may be a minimum deposit amount required for this to happen.
Plus, some banks put a hold on paper checks until they clear the banking system. With direct deposit, account holders don’t need to deal with that delay.
Here’s another benefit. If an employee puts a percentage of each paycheck automatically into a savings account, this can get them into a regular savings habit.
Downsides of Payroll Direct Deposit
When people receiving direct deposits decide to change banks, it may be a hassle. It may take workplaces a period of time to change where paychecks are sent, which means that the old account might need to be kept open longer to make sure all paychecks are received.
How long that period of time may be can vary. But, before you close your old account, ensure that all direct deposits are being put into the new account. Also make sure that all withdrawals and checks have cleared at your old bank and that any automated payments are coming out of the new bank.
Although ATMs make banking simpler for many people, they may come with fees, which can add up. (This downside would also be true if paper paychecks were manually deposited and then, later, funds were withdrawn from the ATM.)
Plus, with direct deposit, it’s important to make sure the correct deposit dates and amounts are recorded. Otherwise, account holders could write checks beyond what’s available, which could trigger non-sufficient fund fees—which, like ATM fees, can be costly, especially when they add up.
To help prevent this, see about setting up bank alerts that indicate when a transaction has been made.
Here’s one more downside. Not everybody in the United States has a bank account. If someone doesn’t but their employer requires direct deposit (more about that, next), then employees without a bank account would likely receive their paychecks through a prepaid debit card.
These can come with fees and, like paper checks, can be lost or stolen.
Employers Requiring Direct Deposit
Just as there are benefits to payroll direct deposit for employees, there are also benefits for employers—including that it’s cheaper to manage payroll payments this way, versus physical checks.
Plus, they have a record of accounts, which makes it easier for companies when they’re reviewing expenses—and they don’t have to reissue a check if an employee loses one.
And, after a person’s payroll information has been entered into the system, paying employees can be faster and easier with direct deposit.
Laws governing payroll direct deposit vary by state and, if a state has no specific laws on this subject, it defaults to federal regulations.
Federal law states that employers must give each employee using direct deposit a summary of rights and liabilities, and must get their signature on an authorization form along with relevant banking information.
Some states allow employers to actually require direct deposit for payroll, as long as the program is administered in a way that’s consistent with federal regulations. Most states, however, still give employees the choice between direct deposit and receiving a physical check.
A handful of states have laws that are unique to them, ones that don’t fit into any of the broad categories already described.
Automating Your Finances
The concept of electronic funds transfers is at the heart of payroll direct deposits, but goes beyond that. Here are additional ways to benefit from automating your money management.
Automation is a tool that can also help people to build an emergency savings account. In general, traditional wisdom says this account should contain three to six months’ worth of living expenses.
That way, if an emergency arises—whether that’s a job loss, an unanticipated repair, or unexpected medical expenses—a financial cushion exists. By setting up a regular funds transfer to a savings account, this can make it easier to build up that emergency fund.
Another strategy to consider: paying bills through autopay. In some instances, lenders may offer a discounted interest rate for borrowers who use automated payments to pay their bills.
Beside the potentially lower interest rate, autopay can help borrowers to make their payments on time, rather than forgetting them when life gets hectic. This also helps to prevent being charged a late fee if a payment is missed, keeping more money in the bank account.
And, because payment history plays a key role (35%) in a person’s FICO® Score, autopay can help to build or preserve a person’s credit score, given that enough money is in their checking or savings account when the payment is due.
Autopay helps to reduce the number of paper bills that need to be sent out—for example, monthly utility bills—and the number of paper checks that may be written to pay those bills. This means that automated funds transfers can therefore be an eco-friendly choice to make.
And, whenever funds are electronically transferred, either in or out of a bank account, a digital record is automatically created. This can be helpful when balancing accounts, creating a budget, looking for tax deductible items, searching for ways to trim discretionary spending, and more.
Autopay might also be a good strategy to use to contribute to a retirement account. Employers are sometimes willing to automatically deduct an amount from employee paychecks to transfer it into a retirement account that’s set up by the company.
Additionally, some employers match retirement account contributions, with these matches sometimes having the potential of doubling the amount of money contributed to an employee’s retirement account.
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Optimal Number of Bank Accounts
To make the necessary financial transactions, how many bank accounts are ideal?
There is no one right answer for everybody. What matters is setting up a system that works well for the person using it to manage their finances.
To help make that decision, here are benefits associated with having just one account, as well as those of having two (or more) accounts, one for bills and another for personal use and pleasure.
First, with a bank account that’s set up strictly for bills and another for personal use, people who use this method can deposit enough money to cover upcoming bills (and perhaps a little bit extra, just in case) into the bills account.
Then they may feel more confident that money left over, whether in cash or in the other bank account, can be spent on a pair of new shoes or a restaurant meal.
And, when that money is directly deposited into the bill-pay account, with bills themselves set up for automatic withdrawal, then that automates the process and saves time.
Other benefits of having multiple accounts include:
• Couples can decide to set up a joint account for bills and then also have individual accounts for independent spending.
• This can be a way to save for a dream vacation or other key goal.
• Freelancers can separate business expenses from personal ones.
And, for people who have their home mortgage at one bank and their car loans at another, it can sometimes make sense to have savings or checking accounts at both if there are any discounts associated with that setup.
Multiple bank accounts may not work for everyone, though. For one thing, if a bank account comes with a minimum required balance—and there are multiple bank accounts requiring one—then a person’s funds might be spread too thin.
If there’s a fee associated with going below the minimum balance with one or more of these accounts, then this strategy may be more complicated and costly than what’s optimal.
Types of Accounts for Direct Deposits
For people who decide to use forms of automated funds transfers, here are some options to consider:
• Checking account
• Traditional savings account
• Interest-bearing savings account
• Certificate of deposit (CD)
• Money market account
Another option is SoFi Checking and Savings®.
With SoFi Checking and Savings, it’s quick and easy to open a bank account online and directly deposit to that account.
Plus, within your overall SoFi Checking and Savings account you can create different vaults for different savings goals, so you only need one account vs multiple to save for different purposes.
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SoFi members with direct deposit can earn up to 2.50% annual percentage yield (APY) on all account balances in their Checking and Savings accounts (including Vaults). There is no minimum direct deposit amount required to qualify for 2.50% APY. Members without direct deposit will earn 1.20% APY on all account balances in Checking and Savings (including Vaults). Interest rates are variable and subject to change at any time. Rate of 2.50% APY is current as of 09/30/2022. Additional information can be found at http://www.sofi.com/legal/banking-rate-sheet