Summary Definition: Compensation added to an employee's paycheck to make up for a shortfall in a previous pay period.
Retroactive pay, or retro pay, is extra income added to an employee’s paycheck to compensate the employee for unpaid work performed in a prior pay period.
To calculate retro pay, simply subtract the amount of wages an employee received from the amount of wages they should’ve received for the work they completed.
The remaining difference becomes retro pay when it’s added to the employee’s next paycheck instead of creating a corrected or second check to cover the amount.
Retro pay is most commonly used whenever an employer owes wages to an employee for work performed in a prior pay period. Needing retro pay means any one of the following could have happened:
While the concept of retro pay seems simple, calculating it involves a few different steps:
Employers can use an automated retro pay calculator to help with this process, but the arithmetic is straightforward enough that it can be done manually as well.
Despite being retroactive, retro pay is still payroll. This means it still needs to have regular tax withholdings and deductions taken out before going to the employee. For this reason, it’s best to use an employee’s gross pay rate when calculating retro pay, not their net pay rate.
Although they both deal with employees not receiving all of their owed wages, retro pay and back pay are applied in different circumstances.
|Why is it needed?
|To correct miscalculations in an employee’s paycheck
|To compensate an employee for wages that were correctly calculated but never received
|What's the amount involved?
|The difference between what the employee was paid and what they should’ve been paid
|The full amount of wages the employee didn’t receive
Employee A earns an annual salary of $50,000, and since she is paid biweekly (26 times a year) her gross pay for each pay period is $1,923 ($50,000 ÷ 26).
During her recent review, Employee A learns she’s getting a $3,000 raise for her performance over the last year. This would mean her gross pay for each pay period would increase to $2,038 ($53,000 ÷ 26).
However, during the first pay period after receiving this raise, the accounting team accidentally forgot to include that raise when calculating Employee A’s gross wages. As a result, Employee A’s gross pay was still $1,923 instead of the $2,038 it should’ve been.
At the end of the next pay period, Employee A received her normal gross pay ($2,038) as well as $115 in retro pay ($2,038 - $1,923) for a total of $2,153 ($115 + $2,038).
Employee B earns an hourly rate of $15.00, and since he’s paid biweekly (26 times a year) his gross pay for each pay period is $1,200.
During the prior pay period, Employee B didn’t receive his wages due to technical problems that crashed his employer’s payroll system. As a result, Employee B had to wait until the following pay period to receive the lost wages he didn’t receive.
At the end of the next pay period, Employee B received his normal $1,200 gross pay as well as $1,200 in back pay for the prior pay period.
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