Salary Advance: Meaning, Benefits, Risks & Alternatives

A salary advance is a sum that employees can request from employers in case of an emergency and have it deducted from their unearned salaries later. In essence, the meaning of a salary advance is quite similar to that of a short-term loan, but in such cases, the repayments have low to zero interest rates.

Employers should establish a seamless process that enables employees to easily borrow money from their unearned wages when necessary. To do that, they should understand how a salary advance works, including its pros and cons and any applicable state regulations.

Key Takeaways

• A salary advance or payroll advance is a short-term loan wherein employees withdraw or request a portion of their future net earnings ahead of the scheduled pay date.
• Employers typically allow at most half of an employee’s monthly net earnings, or 80% of the said sum, as the maximum amount they can allow for a payroll advance.
• Some essential factors that employers consider when approving a salary advance include the loan amount, applicable taxes, the employee’s tenure, and existing state regulations.
• A pay advance offers financial assistance and security to employees, but it can also be a source of debt traps, unmanaged company finances, and possible prejudice in the workplace.

What Is a Salary Advance, and How Does It Work?

A salary advance on a payslip, also called a payroll advance or pay advance, indicates that an employee has requested to acquire a percentage of their unpaid salaries before the scheduled pay date.

This is often the case when employees encounter a financial emergency or need extra cash to help pay their rent, utilities, or school tuition.

Since the setup is quite similar to a regular loan, the payment for the deducted portion of the employee's future salary is usually divided into installments. Employers will then account for the loan disbursement and include it in the employee’s voluntary payroll deductions.

These installments are deducted from the employee’s unearned wages for an agreed-upon number of pay periods until the loaned amount is fully paid. If an employee resigns or is terminated, the remaining balance should be deducted from their final pay.

Some companies may charge a small interest or fee to process a payroll advance, depending on the additional accounting expenses involved. Otherwise, salary advances are usually interest-free.

5 Crucial Factors Affecting Granting Salary Advances

There are five key factors to consider when granting and processing a salary advance, and these are:

#1. Employee’s Reason for Taking an Advance

Some employers require their workers to provide a valid reason for requesting a salary advance, while others do not. Most of the time, a salary advance request for emergency reasons is approved within a workday or as soon aspossible.

#2. Payroll Advance Limits

In general, the minimum amount that employees can take from their future salaries is equal to half of their monthly net pay.

Meanwhile, the maximum amount allowed for a pay advance should be no bigger than 80% of the employee’s earnings. However, it may also vary depending on their monthly net earnings.

Employers must also ensure that the maximum amount they allow for an advance does not take a significant percentage of their employee’s take-home pay. Otherwise, the employee may end up receiving net earnings that fall below the federal minimum wage.

On the other hand, some companies allow employees to increase or decrease the amount deducted from their net salary to pay for the borrowed amount.

#3. Applicable Taxes

Income and payroll taxes also apply to salary advances, and the tax treatment is similar to that of the employee’s regular income. However, the taxes are not deducted from the advance salary or pay itself.

Instead, all applicable taxes are deducted from the total amount of the employee’s future salaries, which covers the amount requested in advance.

Once the taxes are withheld from the employee’s succeeding paychecks, the advance repayment amount is deducted from the amount disbursed to the employee. Thus, employees may not receive the full amount they want to borrow.

#4. State Policies on Salary Advance

Some states require employers to provide a written and signed agreement detailing the employee’s pay advance. Other states also have specific salary advance thresholds based on the employee’s average earnings and the imposed minimum hourly wage in their location.

So, in other words, employers must ensure they adhere to their state’s existing labor regulations when implementing salary advance policies in their company.

#5. Employee’s Eligibility

At times, an employee’s eligibility for a salary advance can be determined by their tenure with the company. Often, a salary advance is granted to employees who have at least completed their probationary period with the company.

Zero disciplinary actions on an employee’s record, whether related to work performance or general conduct while on duty, are also common criteria that employers consider when approving a salary advance request.

How Are Salary Advances Documented on Pay Stubs?

Salary advances are documented on pay stubs by using payroll software to calculate and record all the necessary details about the loan.

The payroll or HR personnel input the following into the payroll or HR system:

• Principal amount
• Date when the salary advance was disbursed
• Interest amount (if applicable)
• Repayment type (lump sum or installments)
• If an employee repays in installments, the number of installments must also be specified in the advance pay stub
• Salary advance balance

Since enabling a pay advance for employees is included in a company’s payroll processing practices, updating an employee’s salary advance every payroll cycle is a must.

A proven method for keeping salary advance details on a pay stub up-to-date is using an advance pay stub. It’s a separate type of paycheck document that only contains information about an employee’s estimated salary advance payments for the succeeding pay periods.

This document effectively prevents mixing up information on an employee’s regular pay with that of their pending repayments.

Conversely, companies can also use a solid paystub generator to track an employee’s regular salary and pay advance status. For example, Paystub.org’s online generator offers ready-made templates, which enable payroll and HR departments to create multiple pay stub copies in minutes.

Once they create the documents, companies can download electronic copies of the pay stubs created through our generator and easily upload them to their system. Additionally, our tool boasts a built-in calculator that ensures that repayments and loan balances are updated with accuracy.

5 Advantages of Getting a Salary Advance

One of the main advantages of getting a salary advance is that it provides a quick and convenient way for employees to get funds whenever they need them.

Besides this, there are also other notable benefits to using a salary advance loan, such as:

• No credit check needed. Unlike other types of loans, a salary advance does not require employers to check an employee’s credit score or credit history to approve their request.

• Flexible repayment options. It is easier for employees to choose and negotiate how to repay their pay advance. They can discuss the terms with the company’s payroll department and track their balances using their pay stubs.

• Easy approval process. Aside from not requiring a thorough credit history check, employees also do not need to provide proof of income to get approved for a salary advance. In most instances, employers base their approval on their employee’s reason for requesting a pay advance.

• Increased employee retention. Providing employee benefits programs that involve convenient financial assistance is an effective way to make employees feel supported and valued by the company.

• Accessible safety net for employees. According to the Money and Mental Health Policy Institute, approximately one in five people suffering from mental health problems faces financial dilemmas that involve debt. Therefore, a salary advance program from employers gives a sense of assurance to employees struggling financially.

4 Possible Drawbacks of Getting a Salary Advance

The drawbacks of getting a salary advance mainly lie in an employee’s capability to practice financial discipline once their repayments are deducted from their regular pay.

If they cannot manage their expenditures, they may face additional challenges and disadvantages that come with a salary advance, including:

• Smaller take-home pay. Getting a pay advance leaves a negative impact on an employee’s financial security in the succeeding months because they don’t receive their net earnings in full.

• Inconsistent payment rates and rules. An effective salary advance program should come with a set of clear and solid policies. A well-thought-out pay advance policy ensures employers adhere to existing state regulations and calculate their payroll accruals correctly.

• Possible debt trap. While the repayment options for payroll advances are more flexible than a typical bank loan, they can also lead employees to fall into a debt trap. Such is the case for employees who continuously and irresponsibly request extensions on their repayment period.

• Exploitative power dynamics. Preparing a written agreement for every approved salary advance request ensures that both parties fulfill their end of the bargain. In some cases, employers may exercise favoritism and limit the payroll advance benefit to a select group of employees.

How to Ask for a Salary Advance

Asking for a salary advance entails employees providing information that’s relevant to their request, namely:

• The amount they want to withdraw from their future earnings
• Their purpose for requesting a salary advance
• Preferred repayment method

Ideally, a salary advance should be reserved for financial emergencies and essential expenses, such as child care, immediate medical needs, death in the family, and property loss following a disaster or calamity.

If their objective for a salary advance does not involve any immediate need, employees can postpone their desired expense until they have saved enough money to afford it.

Otherwise, they should practice due diligence in repaying their loans in the shortest possible time to avoid incurring more interest and debt.

Conversely, employees should consider other available options aside from getting a salary advance that may be more suitable for their financial needs. They should have savings or an emergency fund they can use so they don’t have to take a cut from their future earnings.

Surely, easy access to funds can be enticing, but employees must also have a solid pay stub budgeting plan to account for the months when they begin repaying their loans. Finally, taking time to review their company’s salary advance policies and assess their existing financial obligations could help them make a more sound decision.

Practical Salary Advances Alternatives: 5 Examples

As mentioned briefly in the previous section, there are salary advance alternatives available and worth exploring based on the employee’s financial situation.

These include:

• On-demand pay. It is the opposite of a salary advance in that the employee requests their earned wages ahead of the scheduled pay date. Let’s say an employee who is paid biweekly is due to receive their salary next week; they can have their employer deposit their earned wages in advance.

• Personal loan. On the downside, personal loans take longer to approve and require more paperwork. However, this type of loan is also more practical since it does not take a cut or percentage from an employee's unearned wages.

• 401 (k) debit cards. These are typically offered by employers and enable workers enrolled in the retirement account to borrow a maximum of $50,000 or half of their account’s total value.

• Credit card. It has become common for consumers to purchase and pay their bills using their credit cards. The key is to spend within their credit limits and pay their outstanding balance on time.

• Health savings accounts (HSA). Employees who purchased a health savings account can use their HSA contributions in case of a medical emergency. HSAs may be used to pay for qualified medical expenses, such as prescriptions, vision and dental care, medical equipment, and doctor visits.

Final Thoughts

A salary advance is a convenient and accessible way for employees to get extra funding for any unexpected emergency they may encounter.

However, it may not always be the best option for everyone, as it comes with the possible risks of incurring more debt and facing heavier financial constraints later on. Plus, if there isn’t a seamless payroll administration process, companies may not accurately assess an employee’s eligibility for a pay advance.

Also, if employers are not consistent and strict with their payroll advance policies, they may cause misunderstandings with their employees or leave the company’s finances imbalanced.

Bearing this in mind, employees and employers must collaborate to implement a seamless and transparent process for approving and repaying payroll advance requests.