Retro Pay Explained: Everything You Need to Know

Have you ever received an unexpected paycheck that made you do a double-take? Or perhaps you're an employer trying to navigate the complexities of payroll and ensure your employees are compensated accurately. Well, regardless of which camp you’re in, you might have stumbled upon the term "retro pay."

Retro pay, also known as retroactive pay or back pay, is a concept that can confuse employees and employers alike. In this guide, we will delve into the intricacies of retro pay, explaining what it is, how it is calculated, and why it is important. We will also discuss some compliance considerations surrounding retro pay and provide tips on how to effectively communicate retro pay to employees.

What is Retro Pay?

Retro pay, short for retroactive pay, is a compensation adjustment made to an employee's wages. Usually, retro pay is for work that was performed in the past but wasn't accurately compensated at the time. This situation can arise due to a variety of reasons, such as clerical errors, changes in employment contracts, or miscalculations in overtime, bonuses, or raises. Retro pay may also come into play when an employer makes a pay increase retroactive to a past date.

Imagine you work at a company that implements a pay raise starting in January. However, the raise doesn't make it into your paycheck until February due to an administrative oversight. Or, the pay increase was enacted in February but made retroactive to January. In either case, the additional amount you receive in February to cover January is retro pay.

How is Retro Pay Calculated?

Calculating retro pay involves determining the difference between what an employee was actually paid and what they should have been paid. This requires a thorough understanding of the employee's pay rate, hours worked, and any additional compensation they may have received.

To calculate retro pay, you typically follow these steps: 

1. Gather Data: Determine what change in compensation led to the retro pay situation and collect all relevant data. This includes the effective date of the change, the employee's previous and current pay rates, and the hours or earnings affected. This can also include any overtime, bonuses, or other additional compensation if applicable. 

2. Calculate the Retro Pay: First, subtract the employee's previous pay rate from their current pay rate. This gives you the increase in their pay due to the change. Then, identify the period during which the employee should have received the increased pay. This is typically from the effective date of the change to the present. Finally, multiply the increase in pay by the number of hours or earnings affected for the identified period. For overtime-eligible employees, retro pay for any period in which overtime was worked will be subject to overtime premiums. 

3. Withhold Taxes and Deductions: Remember that retro pay, like regular pay, is subject to  tax withholding and deductions. This includes federal and state income taxes, Social Security and Medicare taxes, and any other applicable deductions. For Federal income tax purposes, the IRS typically treats retro pay as supplemental pay subject to the supplemental pay tax rate.

4. Issue Payment: Finally, issue the retro pay to the employee with their next paycheck, separate from their regular earnings.

It's important to note that the calculation of retro pay can vary depending on the specific circumstances and applicable laws. In some states, retro pay may be subject to late payment penalties. It’s always a good practice to consult an employment lawyer when handling retro payments..

Why is Retro Pay Important?

Retro pay is important for both employees and employers for several reasons:

• Accurate Compensation: The primary purpose of retro pay is to ensure that employees are accurately compensated for their work. It corrects errors or oversights that may have occurred in the past. 

• Employee Morale: Accurate and timely payment of retro pay can boost employee morale by showing that the employer values their work and is willing to rectify mistakes promptly. By promptly addressing retro pay discrepancies, employers demonstrate their commitment to fair compensation practices and employee wellbeing. 

• Compliance: Failure to accurately compensate employees can result in penalties and/or other damages for employers. Be sure to consult a legal expert to better understand your obligations in the jurisdictions you’re in.

• Retention and Recruitment: Fair and consistent compensation practices, including retro pay, can help attract and retain top talent. Employees are more likely to stay with an employer that treats them fairly.

Communicating Retro Pay to Employees

Clear communication is key when it comes to retro pay. Employees may be confused or concerned when they receive an unexpected adjustment in their paychecks. It's recommended to connect with counsel about your communications plan. Here are some things you’ll want to consider:

• Notify in Advance: When you anticipate retroactive pay adjustments, inform employees in advance. Explain the reasons behind the adjustment and provide an estimated timeline.

• Be Transparent: Clearly explain the calculations involved in determining retro pay. Transparency can help alleviate any doubts or concerns employees may have and allow employees to verify the accuracy for the calculations themselves.

• Address Questions: Encourage employees to ask questions if they don't understand the retro pay calculation or its implications. Provide contact information for HR or payroll personnel who can assist with inquiries.

• Update Pay Stubs: Ensure that the retro pay adjustment is clearly indicated on employees' pay stubs. This helps them track the payment and understand their total compensation.

How Justworks Can Help

Now that we’ve covered what retro pay is, why it’s important, how to calculate it, and even how to communicate it to employees, there’s just one step left: choosing a platform to use for payroll, including retro paychecks. Enter Justworks! 

Justworks offers tech-forward solutions that help employers streamline payroll. Justworks PEO is a robust, all-in-one solution that provides payroll, compliance, benefits, and HR services. Justworks Payroll is a lightweight payroll solution, great for small businesses who are just getting up and running. Both options make it easy to implement all kinds of supplemental payments, including, of course, retro pay. Justworks can help employers ensure that retro pay adjustments are well-received and understood by all parties involved, and that ultimately fosters a positive work environment and strong employee-employer relationships for a long time to come.

Ready to explore whether Justworks is a fit for your business? Get started to learn more.