An employee may disclose significant financial difficulties to you, the employer, and the small company owner on rare occasions. Many workers are still dealing with the effects of COVID-19, and with increased inflation, they may face fresh financial difficulties. Being empathetic is an excellent characteristic for owners, but you need also be aware of certain concerns if you wish to assist.
Advances on paychecks
An employee might request a cash advance against an impending paycheck. In other words, you’re giving them money before they’ve earned it. It’s similar to a short-term loan, except there’s no interest. You are not obligated to make this payment. If you wish to do so, consider the following:
- Have a formal policy in place for payday advances. The policy may impose restrictions (e.g., maximum advance amount, how often an employee may obtain an advance). The policy should also specify whether repayment will be made via payroll deductions (the traditional approach) or the employee making extra payments to the firm. Make sure your paycheck advance policy is nondiscriminatory, meaning that if you grant an advance to one employee, you must do so for all employees who meet the policy’s requirements.
- Put it down on paper. Have an employee sign a statement outlining the conditions of the advance. For example, state that $XX will be withheld from future paychecks until the advance is fully returned.
- Know the minimum wage laws. Paying financial advances via payroll deductions does not violate federal minimum wage laws. However, if the employee incurs any charges in getting an advance (for example, accounting fees), they may not reduce their salary below minimum wage.
A payroll advance may be insufficient for an employee’s requirements in a certain scenario. During COVID-19, for example, an electrical firm employee required $5,000 to relocate his family, and the employer was able to help. Keep the following issues in mind when arranging loans to employees:
- A promissory note must be drafted. The loan’s specifics are spelled out in the note, including the loan’s principal, interest rate, and payback dates. Caution: Interest-bearing loans to minimum-wage workers repaid via payroll deductions may not drop a current payment below minimum wage.
- Keep an eye on the lending rules below the market.For the loan duration, you must charge an interest rate that is at least equivalent to the Applicable Federal Rate (AFR) (e.g., short-term, mid-term, long-term). If you don’t, the difference between the interest charged and the AFR is taxable remuneration for the employee, and payroll taxes apply.
- Employees may be unable to repay the debt. They may depart the firm with an outstanding amount in certain situations. Sure, you may attempt to locate and gather them. In reality, an employer should make the loan knowing that it could or might not be returned. Make sure you have enough cash on hand to cover a loan.
Other sources of funding
You may be able to aid financially constrained workers without pulling any money out of the business coffers if they join a qualifying retirement plan.
- An employee may borrow up to $50,000 from the company’s 401(k) plan, up to 50 percent of his or her account. The strategy must allow borrowing while also requiring payback over five years (longer if borrowing is to buy a home). More information about plan loans may be found on the IRS website.
- Distributions from qualifying retirement programs in times of need. Plans may provide distributions in the event of a significant and sudden financial difficulty, such as the cost of a spouse’s death. Employees may be liable to a 10% penalty if they are under the age of 5912 unless they qualify for a penalty exemption, such as paying specific medical expenditures. More information about hardship distributions may be found on the IRS website.
Employees may benefit from financial literacy training, which encourages them to save money and build an emergency fund while also learning about budgeting, debt management, and investing. While the employer is not required to act as an instructor, the company can arrange for information from the company’s CPA, a firm with which the company already works (e.g., an insurance or brokerage firm), or a company that specializes in financial fitness programs to be provided during lunch or after hours (e.g., Financial Fitness Group).