What is Retro Pay and How can it be Calculated?

Highlights

• Retro pay compensates employees for previous underpayments, such as missed overtime or delayed raises.
• It's important for correcting payroll errors, ensuring pay increases, and maintaining employee trust.
• Retro pay can apply to overtime, wage increases, bonuses, commissions, and payroll system errors.
• Calculating retro pay involves identifying errors, calculating the pay difference, and accounting for taxes.

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Imagine a team member checks their paycheck and notices something’s off. Mistakes happen, whether miscounted hours, a missed raise, or an overlooked bonus. So, how do you fix these errors? That’s where retroactive pay comes in.

Retroactive pay ensures employees receive the full amount owed by correcting payroll errors. So, in this guide, we’ll break down what is retro pay, when to use it, and how to calculate it to keep your team satisfied and your business on track.

What is Retro Pay?

Let’s start with the basic question: what is retro pay?

Retroactive or retro pay is compensation owed to an employee for previous underpayment. There are many reasons someone might not receive the correct pay, including delayed promotions, incorrect overtime calculations, and payroll system errors.

Once identified, HR system teams process retro pay in the next payroller or as a special payment.

What is Retro Pay in Payroll?

Retro pay in payroll refers to wages paid to an employee for work performed in the past but was not paid when it was originally due. This typically happens when there's a mistake in the employee's paycheck, such as underpayment, miscalculation of hours, or missing overtime pay. 

Moreover, it can occur if an employee’s pay rate or salary increases, and the retro pay covers the difference for the period before the raise was applied. Retro pay ensures the employee is compensated for the full amount they should have earned during that time.

Why is Retroactive Pay Important?

What is retro pay, and how does it help maintain fairness, build trust, and reduce legal risks, all of which contribute to a more satisfied workforce and a positive workplace culture? It allows the HR management system to:

• Correct Payroll Errors: Payroll mistakes can lead to employee dissatisfaction. Addressing these errors quickly helps maintain morale and prevent retention issues.
• Ensure Timely Pay Increases: Raises reflect an employee’s value to the company. If a salary increase isn’t applied immediately, retro pay ensures they receive the correct amount from the intended date.
• Strengthen Company Culture: Efficient retro pay fosters trust and fairness. When pay discrepancies are resolved quickly, employees feel valued, leading to a more engaged and productive workforce, which boosts productivity.
• Reduce Compliance Risks: Payroll regulations can be complex. Understanding what is retro pay laws and addressing miscalculations promptly helps avoid compliance issues.

When to Use Retro Pay?

We have a basic understanding of what is retro pay, but here are common scenarios where retro pay applies:

• Overtime Pay: If overtime hours are miscalculated or overlooked, retro pay ensures employees receive the correct compensation for the extra hours.
• Wage Increases: Delayed processing of salary adjustments due to raises or promotions can be corrected with retro pay, ensuring employees receive the increase from the agreed-upon date.
• Supplemental Income: Bonuses, tips, or other supplemental wages missing from a paycheck can be adjusted through retro pay. A strong compensation strategy includes plans to handle these adjustments effectively.
• Commission: If commission-based earnings are miscalculated, HR can issue retro pay to correct the discrepancy and ensure employees receive what they’ve earned.
• Shift Differential: Employees working late shifts, weekends, or holidays receive higher pay rates. If these premium rates are overlooked, retro pay can correct the error.
• Payroll System Errors: While automatic payroll reduces mistakes, occasional system glitches or human errors happen. Quick adjustments through retro pay help maintain employee trust and payroll accuracy.

What is Retro Pay Example?

Retro pay is needed when a previous pay period doesn’t reflect necessary compensation changes. Some common reasons for retro pay include:

• Pay raises: If an employee’s pay raise was promised but not properly applied.
• Overtime: If overtime hours were worked but the pay was miscalculated.
• Commissions: If commissions weren’t paid due to a delay in client payments.
• Bonuses: If an employee’s bonus was underpaid.
• Payroll errors: If mistakes in payroll processing lead to incorrect earnings.
• Shift differentials: If an increased rate for hours worked outside the regular shift wasn’t applied.

Employees may seek retro pay and pursue legal action for claims such as discrimination, retaliation, breach of contract, or violations of minimum wage or overtime laws.

How to Calculate Retro Pay?

Now that you know what is retro pay, let’s move on to the next step of calculating it:

Determine if the Employee is Hourly or Salaried

Start by identifying whether the employee receives hourly wages or a salary. This can be done by checking previous pay stubs or reviewing their contract. Retro pay might be necessary if the employee recently switched from hourly to salaried pay. 

For example, a Cool Blue Candle Company accountant notices that Sarah, a manufacturing department employee, didn't receive the correct pay. After reviewing Sarah’s contract, the accountant confirms she is hourly, costing $19.

Check Eligibility for Overtime

Next, determine if the employee is eligible for overtime pay. Most salaried employees do not qualify for overtime, but checking their contracts for specific terms is important. In Sarah’s case, she is eligible for overtime, as confirmed in her contract.

Identify Pay Periods with Errors

Review past pay periods to find where errors occurred. Errors often happen after a raise or promotion, especially if these changes aren’t reflected in the payroll system. For example, Sarah received a raise from $19 to $20 per hour more than a month ago, but three full pay periods were missed for this increase. The accountant tracks these periods to ensure they are corrected.

Manually Calculate the Retro Pay 

After identifying the pay periods with errors, calculate the difference in pay for those periods. To do this, multiply the hours worked by the difference in pay. For example:

Sarah worked 40 hours weekly for three pay periods, with two weeks per pay period.

40 hours/week × 2 weeks/period × 3 pay periods = 240 total hours.

The difference in her hourly rate is $1 ($20 - $19), so the retro pay is:

240 hours × $1 = $240 retro pay.

Account for Taxes 

Before disbursing the retro pay, ensure the correct amount of taxes is withheld. For example, if Sarah's tax rate is 14%, the accountant will calculate her retro pay after taxes:

$240 × 0.86 = $206.40 retro pay after taxes.

Summary

Knowing what is retro pay and its importance helps employers and employees maintain fairness and trust in the workplace. Whether it's correcting payroll mistakes, adjusting for pay raises, or compensating for missed overtime, retro pay is crucial in keeping pay practices accurate and transparent. Payroll and HR teams must have a clear process for calculating and issuing retro pay to prevent discrepancies and foster a positive work environment.

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