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How Direct Deposit Works

Written by Kevin L. Matthews II

When was the last time you received a paper check on payday? For most people it may be difficult to remember. This is because many employers have nudged the use of direct deposit for its employees. In fact, nearly two-thirds of people who use direct deposit say their employers’ practices affect their choice to get their paychecks via direct deposit, according to the National Automated Clearing House Association. Additionally, some banks will allow you to sidestep fees when you sign up for direct deposit as well. This is one of the reasons 82% of U.S. workers receive their regular pay through direct deposit via ACH, making it the most popular way to get paid.

What is direct deposit?

Direct deposit is an electronic payment from one party to another. Receiving payments in this way is the fastest, most reliable method available and eliminates the need for getting paid via check or cash.

What is the Automated Clearing House?

The Automated Clearing House is an electronic network that connects all U.S. financial institutions and allows banks to process transactions in a quick and cost-efficient manner. The ACH Network started in 1974 and is run by NACHA – The Electronic Payments Association. In 2016, there were more than 25.5 billion ACH transactions, according to the network’s most recent annual report. Direct deposits and direct payments are the only two transactions that the Automated Clearing House processes.

How does direct deposit work?

Banks rely on the Automated Clearing House (ACH) to execute direct deposit transfers. All transactions begin with what is called “The Originator.” This is the person or company that begins the process. The National Automated Clearing House (NACH) then describes the process as the following:

  • Once the originator requests the transaction, the Originating Depository Financial institution (ODFI) starts the ACH entry.
  • The ODFI creates bulk payments from customers and sends them periodically to the ACH Operator at preset times throughout the day.
  • ACH Operators receive these payments of ACH entries from the ODFI.
  • The ACH Operator sorts the transactions and makes them available to the Receiving Depository Financial Institution (RDFI).
  • The receiver’s account is updated by the RDFI, according to the type of ACH entry (deposit or payment).
  • ACH payment transactions settle in one to two business days. Deposit transactions settle in one business day.

How to set up direct deposit

Setting it up is a pretty simple process and is often made easier if you’re accepting payments from your employer. Depending on your bank or credit union, there may be a few differences, but these principles should hold true:

  1. If you don’t have one already, you’ll need to open a bank account.
  2. You will need to get your bank’s routing number, type of account (checking or savings) and account number, and provide this information to your employer. In some cases, you may be required to provide a voided check. For this step, your bank may also be able to provide a form to give to your employer as well.
  3. Monitor the account and make sure the funds were deposited correctly.

Benefits of direct deposit

Here are some of the biggest benefits:

  • More than 70% of direct deposit users say they feel in control of their finances, according to a 2016 survey published by NACHA – The Electronic Payments Association.
  • It does not have an associated cost.
  • It is safe and secure.
  • You have quick access to your money; 53% say the service’s key benefit is fast access to their pay as the need to deposit or cash a payroll check is eliminated, according to the 2016 survey.

Disadvantages of direct deposit

For most people, there aren’t many drawbacks, but that does not make the service perfect. If you’re someone who prefers using cash, direct deposit may force you to make frequent trips to the ATM, and if you don’t have any of your bank’s ATMs near you, you could end up paying ATM fees. Another disadvantage may occur when changing banks for direct deposit purposes. Depending on your company and pay schedule, it may take a few weeks for the changes to reflect in your account. In some cases, this may cause a delay in receiving a deposit or making a payment.

Which types of accounts can work with direct deposit?

This service is primarily used for receiving your income from your employer but there several other types of payments you can receive.

  • Social Security: Beginning March 1, 2013, a law went into effect requiring Social Security payments to be made via direct deposit. If you do not comply with the law, you should expect a call from the Department of Treasury.
  • Tax refunds: You can receive your tax refund sooner through this service. You may also choose to deposit the money in up to three accounts.
  • Investment accounts: Just like your checking and savings, your investment accounts have a routing number. You can simply enter the information and allow the direct deposit to flow directly to your investment account. For IRAs, you’ll want to make sure you do not deposit above the contribution limit.

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