Could the best way to keep your employees be to pay them early?
That's the promise of on-demand pay, ie, earned wage access (EWA) services that pay employees for the time that they work ahead of the regular pay period. It's increasingly being offered by fintech companies such as ADP, DailyPay, Payactiv and Wagestream, with plenty of emerging startups being funded to bring new business models to the market.
These providers typically pay out an employee's earned wages ahead of payday, then collect the funds from companies at the end of the month for a fee. And, perhaps unsurprisingly, given the cost of living crisis, it's catching on. While fintechs have primarily focused on major companies – Amazon and Walmart offer the service – experts say it's likely that small businesses will be the next wave to give the trend a try. But there's no such thing as free money – and, in a still-regulating industry, companies need to do their research before jumping on board.
Saying yay to early pay
So far, it appears to be a benefit that employees use: The Clearing House, a banking association and payments company, found that instant payroll transactions across its network spiked by 300% over the past year – growing from more than 1.52 million in the third quarter of 2021 to more than 6.08 million in the same period in 2022. Activity has also grown across income and geography – in the UK, a significant portion of middle-income workers are utilizing these services, while fintechs operating in emerging markets have seen 10 times year-on-year growth.
For workers, ‘being able to have those funds when they need it can actually be [a] budgeting tool [as] they don't need to rely on loans,’ says Elena Whisler, senior vice-president of sales and relationship management at The Clearing House. ‘That's quite significant today with interest rates rising [and] with inflation still quite high.’
The Covid-19 pandemic saw an increase in digital and contactless payments, meaning people needed faster access to funds. An increase in contract work in fields such as healthcare, retail and software development have also played a role: ‘There [are] more and more independent contractors that may want their payroll or their payments done [on] a more frequent basis,’ says Elena.
Retention – one of the biggest challenges for employers in the year of the Great Resignation – is a big driver for adoption, and it seems to be having some impact. Research by DailyPay and Mercator Advisory Group found that workers stuck around longer when offered on-demand pay, with retention rates increasing by 24% for retail employees and 15% for restaurant and fast-food workers.
At an Australian sports club that previously had to close early because it didn't have enough staff to cover the bar, nearly half of its 100 employees used the service, leading to an increase in people picking up shifts.
The shadow of payday lending
It's difficult to bring up any talk of early pay without thinking about payday loans – predatory loans that charge extortionate interest rates for money over a short term.
EWA services have distanced themselves from payday loans by packaging services as part of a financial wellbeing benefit. But these services can be different in practice, says Boris Vallée, a Harvard Business School professor who has studied EWA. The services often impose limits on how frequently and how much money workers can withdraw and pay out wages already earned, rather than the full amount of a paycheck.
However, the industry has caught the attention of regulators due to services that charge workers for early access to their funds and for hidden fees, such as the cost of loading funds onto prepaid debit cards. While not quite the high interest rates of payday loans, these fees aren't insignificant – especially if an employee is using the service repeatedly – as the National Consumer Law Center (NCLC) found: ‘A $100 advance taken out five days before payday with a $5 fee or “tip” is equivalent to an annual percentage rate of 365%.’
With this in mind, regulators are still weighing up how to address the industry. A lot of debate is focused on whether EWA programs are offering lines of credit and requiring employees to pay for access, and how some players are touting regulatory approval before a concrete decision is made. All in all, there are signs that the industry might want to move faster than regulators are comfortable with.
No such thing as free money
While some companies charge employers for early wage withdrawals, others charge the employees instead – so small businesses could avoid the cost. Deciding which is the right move is down to each business – offering EWA might cost less in the long run than having to recruit new talent. Giving employees the option to get paid early without a fee is more compelling for workers, and it could make sense for employers to cover the fees if it's not too high of a cost to bear, Boris says.
‘I think there's a rationale for the employer to bear that cost and that the employee will value [EWA] potentially more than it's costing the employer,’ he says.
When assessing whether a program will be useful for employees, the NCLC suggests that employers consider whether an EWA is employer-based (meaning it's integrated into payroll) or direct to consumer (which makes estimations on time worked and doesn't require employer approval), plus they should dig into repayment methods and whether they could lead to extra fees. Ultimately, however, it points out that employers should first ensure that they're paying employees a livable wage with regular work schedules and savings options before offering workarounds.
‘Free options for more frequent or early pay are growing, but policymakers and employers should not leap to endorse services that merely result in added fees for workers,’ the NCLC says.