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Banking 101: How Direct Deposit Works and How to Set it Up

Written by Devon Delfino | Published on January 23, 2020

Note: This article is part of our Basic Banking series, designed to provide new savers with the key skills to save smarter.

Direct deposit is a form of automated electronic funds transfer from one party to another. Typically, direct deposit is how your employer transfers your salary or wages to your bank account, but it is also one method to transfer money between your personal accounts.

Direct deposits are generally the fastest and most convenient way to transfer funds, and they are usually the quickest way for most people to collect a paycheck on a recurring basis. We cover what direct deposits are, how they work, and how you can set one up.

In this article we will cover:

What is direct deposit?

Direct deposit is the electronic transfer of funds from one party to another. For example, If you receive Social Security and sign up for direct deposit, your regular payments are deposited straight into your account, with no further effort necessary by you. When you enroll in direct deposit with your employer, your salary is routed straight to your account on payday — no need to cash a check. Qualify for a tax refund this year? You have the option to receive it by direct deposit.

Direct deposit is facilitated by the National Automated Clearing House Association (NACHA), which operates the ACH network. This core component of the U.S. financial system processes nearly 23 billion payments a year, including:

  • Social Security payments
  • Income tax refunds
  • Investment account deposits
  • Travel reimbursements
  • Dividend and interest payments

How long do direct deposits take to reach my account?

Once you’ve set up direct deposit with an employer or the government, you should receive your money at the start of the business day on which you are regularly paid. If you’ve only just signed up, it can take one or two pay periods for your direct deposit payments to start flowing into your bank account or prepaid debit card, depending on your frequency of pay, when you submit the authorization form and how long it takes your employer or the government to process your information. During that time, you may receive a physical check.

How to set up direct deposits

To set up direct deposit, you'll need to provide some personal information to the entity that will be making the deposits to your account. The information required will vary depending on the kind of direct deposit you want to set up. If you receive Social Security benefits, you’d create a My Social Security account to set it up. If you want to set up direct deposit to get your tax refund, like about 80% of taxpayers do, you’d simply select direct deposit on whatever tax software you use and provide your account and routing numbers. Or if you use a tax preparer, you’d let that person know you want direct deposit and provide the necessary information.

For those who want to set up direct deposit with your employer, here’s a step-by-step list of what you’ll need to do:

Request a direct deposit form

You’ll start by filling out a form for your employer. Some employers, and even some states, will require direct deposit, in which case you probably won’t have to request the form. But for many it will be optional, so a request for the form will be required to get the ball rolling.

Gather the requested account information

The required information may vary slightly from employer to employer, or other institutions, but in general you’ll need to provide the following:

  • Name of bank or prepaid debit card issuer
  • Account routing number
  • Bank account or prepaid debit card number
  • Type of account (checking, savings, prepaid debit card)
  • Account holder name
  • A voided check

Consider your account options

You may want to have all of your cash deposited into your checking account, for easy access, but you don’t have to opt for that if you don’t want it. For example, you could decide to automate your savings by indicating that you want a certain amount of your regular deposits to go into a savings account.

Return your completed direct deposit form

When you’re ready, return the form to the designated authority and wait for direct deposit to begin. Keep an eye on your account when it’s time to make sure that it is set up correctly. And, as noted above, keep in mind that it may take more than one pay period to start. After that, be sure to update your information — if you change banks, for example — when needed to avoid payment disruptions.

Reasons to use direct deposit

Direct deposit can be a great financial tool for many employees and benefit recipients, with the advantages of direct deposit including:

  • Convenience: Automatic payments mean you don’t have to make a trip to the bank every time you get paid. If you decide to split your payments, it can also enable you to setup easy savings to hit your financial goals more easily, or fund a retirement account.
  • Quick payments: Once it’s enabled, you could get paid faster than previously, typically on the start of business on the day of deposit. And not only does it appear in your account faster than, say, waiting for a check in the mail — it also means skipping the waiting-period that comes with making sure the check clears before you can start spending it.
  • Security: Since it’s automatic, it doesn’t have to pass through human hands to get to you. It’s also more secure than carrying out cash, or even a check.
  • Digital record of payments: If you usually get paid in cash, the fact that direct deposit can give you a digital record of your payments is extremely useful and it can help you both understand your finances more thoroughly.
  • Fee free: There are no extra costs associated with direct deposit. If you have a bank account, it can help you avoid fees that are sometimes charged for using other payment options, like check-cashing services.

Still, there may be downsides for some people, like those who prefer holding cash or don’t like making frequent trips to the ATM. And if you don’t have a bank account or a prepaid debit card, direct deposit isn’t really an option.

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