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What is Retro Pay: Meaning, Calculation & Taxes
What is Retro Pay?
Retro pay also known as Retroactive pay, refers to the compensation owed to any employee for a work done by them in the previous period but not paid at that time. It typically arises due to adjustments in wages or salary rates that are implemented retroactively, resulting in the needs to compensate employee the difference between what they got vs what the actually need to get.
Why retro pay might occur?
There are various reason for Retro pay:
- If an employee salary is increased due to promotion or general wag increase in compensation retro pay helps ensure that the employee are compensated correctly for the work performed during the period.
- In unionized environment, retro pay may be required when new labor law or agreement are implemented in the business. This ensures employees are compensated at the negotiated rates for all the work performed during the period.
- If error occurs in payroll such as incorrect wage rate, missed hours, not accounting overtime pay etc. then employer can use retro pay to rectify these mistakes and ensure that employees receive the correct compensation for their work.
- Changes in labor law, minimum wages, or other regulatory requirement may necessitate retro pay by employer to ensure compliance with the new standards. retro pay makes sure employees are compensated appropriately for their work performed during the period.
How to Calculate Retro Pay?
Here’s how you calculate retro pay:
- Determine the effective date of changes in compensation such as date of promotion, raise or start of new pay period.
- Collect payroll information of the employee which include current pay rate, effective date of the change, and the pay prior to the change.
- Calculate the difference between employee’s old pay rate and new pay rate for each period affected by the change.
- Determine the number of pay periods that are affected by the change in compensation. this include bi-weekly, month.
- Multiply the difference in pay rates by the number of pay periods affected to determine the total retroactive pay owed to the employee.
- Take in to account any taxes or deductions such as federal, state and local taxes that needs to be applied to retro pay.
- Once the retro pay is calculated issue the payment to the employee either as a separate payment or include it in their regular paycheck.
Formula for calculating retro pay:
Retro Pay = (New Rate – Old Rate) * Hours Worked
Where:
- New Rate: The new pay rate after the increase in compensation.
- Old Rate: The previous pay rate before the increase in compensation.
- Hours Worked: The number of hours worked by the employee during the pay period.
Retro Pay vs. Back Pay
| Aspect | Retro Pay | Back Pay |
|---|---|---|
| Definition | Compensation owed to employee for work performed during a previous period at an updated rate. | Compensation owed to employee for work performed but not previously paid or underpaid. |
| Timing | Arises due to changes in compensation rates that are implemented retroactively. | Arises due to errors, disputes, or delays in payroll processing. |
| Cause | Typically results from promotions, raises, labor agreement changes, or regulatory adjustments. | Often occurs due to payroll errors, disputes, violations of labor laws, or delayed payments. |
| Calculation | Involves determining the difference between the old and new pay rates and multiplying it by the number of affected pay periods. | Involves calculating the total amount owed based on the original agreed-upon rate and the actual amount paid. |
| Example | Employee receives a raise that is applied retroactively to the start of the quarter, resulting in additional compensation for previous work. | Employee’s paycheck is delayed due to a payroll processing error, and they receive the missed wages in a subsequent payment. |
| Legal Implications | Typically arises from planned changes in compensation and is less likely to lead to legal disputes. | May result from legal claims, grievances, or violations of labor laws, potentially leading to legal action if not resolved satisfactorily. |
How do you issue retro pay?
There are three ways to issue retro pay:
- Employer can issue a separate cheque to employees in the form of separate payment, labeled as retroactive compensation.
- Employer can add the retro pay in the next regular paycheck and label it as “Retro” for transparency.
- Employer can also add it to regular pay without specifically labelling it as retroactive compensation.
How is retro pay taxed?
Retro pay is typically taxed in the same manner as the regular wages, following the guidelines set by the federal, state and local tax laws.
- Retro pay is subjected to federal income tax just like regular wages where amount are withheld depending on the employee tax filing status.
- Depending on the state where employee work they might be eligible to pay state tax on retro pay. The withholding rules vary by jurisdiction.
- Retro pay is also subjected to Social Security and Medical Taxes at same rates as regular wages.
- Retro pay may also be subjected to other withholdings such as local taxes, wage garnishment or court ordered deduction.
What does retro mean on a pay stub?
On pay stub “retro” means retro pay made to an employee compensation. This appears as separate line item or as a part of the overall earnings for the current pay period depending on the payroll system and how they are processed.
