What does paid in arrears mean?

“In arrears” means a payment is late or overdue. When you’re in arrears with a utility bill or a mortgage payment, you could face additional fees or consequences.

“Paid in arrears” has a slightly different meaning. Also known as an arrearage, payment in arrears means you pay someone after they complete work. You can also pay in arrears for services rendered or delivered goods. 

Handling payroll in arrears

It’s common for companies to process payroll in arrears rather than paying in advance or current. This applies to all pay period frequencies, including weekly, biweekly, monthly or another schedule.

When you pay in arrears, you typically pay on a specific date. For payroll, this means setting a pay period with a predetermined date on which your employees receive their compensation for that period. You pay employees about three to five days after the end of each pay period. For example, if your workweek starts on Monday and ends on Sunday, you would pay your employees the following Friday. This is five days after the end of the workweek.

Giving yourself a few days to calculate payroll helps you comply with the withholdings and other payroll responsibilities. Employees who miss work, trade shifts with coworkers or use unplanned PTO also create more work for your payroll team. Paying in arrears gives your payroll team time to review any changes, such as missed work, traded shifts or unplanned PTO, and calculate the correct paycheck amount. 

Example 1

Darius Johnson works his usual 8am-5pm shift on Monday, Tuesday, Wednesday and Thursday, but he takes Friday off. After the workweek ends on Sunday night, Darius’s employer calculates his wages, including paid time off. Darius gets paid the following Friday, five days after the end of his previous workweek.

Example 2

Samantha James works part-time on Monday, Tuesday and Wednesday. Samantha’s line manager asks her to work an additional shift on Thursday. Samantha goes back to her usual part-time shift on Friday. After the workweek ends on Sunday night, Samantha’s employer calculates her wages, including the extra shift. Samantha gets paid the following Wednesday, three days after the end of her previous workweek.

Other examples of paying in arrears

While paying in arrears is common for regular employees, it also applies to other circumstances. Many independent contractors and vendors send invoices after they complete work or perform a service, which is called billing in arrears. Here are two examples.

Example 1

Every week, a cleaning company deep cleans a real estate agency in town. At the end of the month, the cleaning service sends the real estate agency a bill for work done during that service period. The agency pays in arrears for the services provided by the cleaning company.

Example 2

A company hires a freelance writer to create website content and email templates. The writer completes the work and sends an invoice after delivery. Invoices typically include a payment due date to inform the company when it needs to pay the amount. 

What does paid in advance mean?

When someone is paid in advance, they’re paid in full before they begin working. Manufacturers usually require full payments in advance before they begin production runs. Lawyers and other professionals frequently work on retainer, a type of advance payment. This payment method is less common for regular employee salaries.

Types of payment in advance

Paying in advance can take different forms. Sometimes, an advance payment covers the whole of a project or period of work. Others require a rolling advance payment for ongoing services. Here are a few types of advance payments.

Salary advance

A salary advance is a short-term loan given to an employee that allows them to access their wages before the scheduled payday. You pay your employee a lump sum, and they pay it back over several weeks or months from their future earnings. Employees typically pay salary advances back via deductions on the employee’s paychecks.

Retainer

When you pay someone on retainer, you pay them in advance for a certain number of billable hours or services. A retainer agreement is a work-for-hire agreement rather than a traditional employment contract. Some independent contractors offer discounts if their clients pay retainer fees rather than opting for traditional invoices.

Paid current

Paid current isn’t technically paid in advance, but it’s faster than paying in arrears. It means you pay an employee or an independent worker at the end of a workday or at random intervals throughout a pay period. Some companies give employees flexible access to the wages they’ve earned rather than making them wait for a specified payday after the pay period ends. 

Pros and cons of payment in arrears

Looking at the pros and cons of handling payroll in arrears can help you decide if it’s the best payroll method for your organization. 

Pros of payroll in arrears

Some perks of paying in arrears include:

• Payroll accuracy: When you pay employees for work they’ve already completed, you’re not estimating or projecting their workload. You can calculate the pay based on their actual worked hours, increasing the accuracy of your calculations.

• Increased payroll calculation time: Handling payroll in arrears means you typically have several days between the last day worked and payday. This gives you time to run payroll with the calculations for PTO, benefits and other factors that depend on the hours worked.

• Lower risk of losses: If you pay in advance, you risk compensating workers for projects they don’t complete. 

• Improved budgeting: Paying in arrears lets you set pay periods and dates. You know when the funds will leave your business account so you can plan accordingly. You also get used to paying roughly the same amount each payday.

Cons of payroll in arrears

There are some potential downfalls to paying your employees in arrears. Issues to be aware of include:

• Financial difficulty for staff members: Employees have to wait a few days after the end of a pay period to get paid, which could cause financial stress. This can be particularly true if you pay monthly. Some people find it more challenging to budget when they’re paid monthly. They also have to wait several weeks to receive compensation for the work they complete at the beginning of the month. 

• Delayed first paycheck: When you hire a new employee, they may have to wait an additional pay period before receiving their first paycheck. 

• Risk of falling behind: Paying in arrears gives you time to receive revenue from customers. However, you risk falling behind on payroll. 

Pros and cons of payment in advance

Payments in advance also come with pros and cons. Consider these factors before opting for this method: 

Pros of paying in advance

The pros of making payments in advance include:

• Providing fast access to pay: Employees don’t have to wait to be paid, which helps them pay their bills quickly and often boosts employee morale.

• Accommodating employees’ needs: Some paid in advance options can help employees under financial strain. A salary advance may help cover an unexpected, urgent expense for one of your team members. 

• Building trust: If you work with freelance employees, you can establish trust by paying them in advance or paying retainers. This helps provide a sense of security knowing they’ve already been partially paid for their work.

Cons of paying in advance

There are some drawbacks to various paid in advance methods, including:

• Inaccurate calculations: If you pay regular employees for their work in advance, you might calculate pay inaccurately based on projected work hours. This can create more work when you need to correct the errors.

• Unfinished work: In some cases, employees may not complete the work, or contractors might fail to finish the project. Getting the money back can create more work for your company as you determine how to recoup those funds.

Best practices for payroll

It’s essential to pay your employees on time to foster a healthy workplace. Use these best practices to avoid issues:

• Choose your method: Based on your business structure and employees’ needs, decide between paying in arrears and paying in advance.

• Document it: Create a written company policy that details how and when employees are paid. Include a chart of pay periods and paydays. 

• Create procedures: If you offer special pay options, such as payroll advances, consider establishing procedures for managing those situations. 

• Ensure compliance: Review federal and state payroll requirements to ensure your selected method complies with regulations. 

FAQs about paying in advance vs. paying in arrears

Is paying in advance or in arrears better?

Businesses typically pay regular employees in arrears to ensure accuracy and improve labor cost budgeting. Every business differs, so you should adjust your payroll practices to match your needs. Work with your HR department to establish effective payroll procedures. You can also consult with external tax, payroll and benefits specialists to understand the impact of your payment method.

How do you switch payroll methods?

If you’re switching from employees being paid in advance to paid in arrears, clarify the new procedures internally. Then, let your employees know about the change. This allows them to prepare for pay gaps to minimize the financial impact of the change. Help settle any unease by discussing the benefits, such as improved accuracy. 

What is the difference between payment in arrears and late payments?

Payments in arrears typically indicate you’ve agreed upon a payment day. For payroll, you have an established pay schedule and employees know when they’ll receive compensation. If you’re paying vendors or suppliers in arrears, you have an agreement to pay by a certain date. Late payments mean you’ve already passed a bill’s due date and don’t have a payment agreement.