Retro Pay

As a business owner or human resources manager, you may come across the term 'retro pay' in the context of employee compensation. Retro pay, short for retroactive pay, refers to additional compensation owed to an employee when they were underpaid in a previous pay period. This can occur due to payroll errors, delayed implementation of pay raises, or miscalculations of overtime. Understanding retro pay is important because promptly correcting pay discrepancies ensures compliance with labor laws and maintains employee trust.

For example, suppose an employee received a pay increase from $20 to $22 per hour, effective two pay periods ago, but due to an administrative oversight, their paycheck still reflects the old rate. To rectify this, you would calculate the difference of $2 per hour and multiply it by the total hours worked during the affected pay periods. This additional amount would then be included in the employee's next paycheck as retro pay, ensuring they receive the full compensation they are entitled to.

What Are Some Examples of Retroactive Pay?

There are a few different reasons why an employee might be entitled to retroactive pay. Some examples include:

• Delayed Pay Raise: An employee receives a pay increase, but the adjustment isn’t processed until after one or more pay periods have passed. The employer then pays the difference retroactively.
• Overtime Pay Miscalculation: An employee works overtime hours that are not compensated at the correct overtime rate. The employer must then calculate the difference and issue retro pay to cover the underpayment.
• Payroll Errors: Mistakes such as incorrect hourly rates or missed shift differentials are identified after the payroll has been processed, necessitating a retroactive adjustment.

How To Calculate Retroactive Pay?

Calculating retroactive pay involves determining the difference between what the employee was originally paid and what they should have received. 

This calculation differs depending on whether you need to pay retroactive pay to a salaried employee, or to workers being paid an hourly rate.

Calculating retro pay for salaried employees

For example: A salaried employee received an increase of 10%, taking their annual salary from $75 000 to $82 500. They were supposed to start receiving their new salary two months ago, but they’ve continued to receive their original salary in error.

To calculate their retro pay, you have to know:

• Their previous annual salary ($75 000)
• Their new annual salary ($82 500)
• The effective date of the new annual salary 

Next, follow these steps:

• Calculate their original monthly salary: $75 000 divided by 12, which is $6 250
• Calculate their new monthly salary: $82 500 divided by 12, which is $6 875
• Calculate the difference between the two monthly salaries by subtracting the previous monthly salary from the new monthly salary: $625
• Multiply this number by the period affected by missed payments, in this case two months. 

Therefore, the salaried employee will receive $1 250 in retro pay.

You should also take into account any requirements around remuneration that might affect your calculations in a specific region. For example, in some countries 13th month salaries can form part of an employee’s annual base salary - in this case, you would divide by 13 to get the monthly salary amounts.

Calculating retro pay for hourly employees

For example: An hourly employee should have received a raise from $14 to $16 two weeks ago, and is paid weekly. During this time, they’ve worked 90 hours in total.

To calculate their retro pay, you have to know:

• Their previous hourly rate ($14)
• Their new hourly rate ($16)
• The effective date of their raise
• The number of hours they worked at their previous hourly rate, since the new rate should’ve taken effect (90 hours in this example)

Next, follow these steps:

• Calculate the amount the hourly rate increased ($2 in this example)
• Multiply the hours they worked at their previous hourly rate by the hourly increase: 90 x $2.

Therefore, this hourly employee will receive $180 in retro pay.

The total retroactive pay is added to the employee’s next paycheck or issued as a separate payment, with applicable taxes and deductions applied. 

What Is The Difference Between Retroactive Pay And Back Pay?

Retroactive pay and back pay are often confused, but they serve different purposes. Retroactive pay refers to adjustments made for discrepancies within the same role, such as missed raises or incorrect pay rates. 

Back pay, on the other hand, is typically awarded due to legal disputes, such as unpaid wages for work performed or compensation owed due to wrongful termination. While both involve compensating an employee for unpaid wages, back pay usually results from a legal ruling or settlement, whereas retroactive pay is a correction of prior payroll processing errors.

Retroactive Pay FAQs

How is retroactive pay taxed?

‍Retroactive pay is taxed the same as regular earnings – what these taxes amount to differs by country. For example, in the U.S., this means that federal income tax, Social Security, Medicare, and any applicable state or local taxes will be withheld.

How long does an employer have to pay retroactive pay?

‍The time frame for paying retroactive pay can vary depending on labor laws and employment contracts. Generally, employers should address and correct any payroll discrepancies as soon as they are identified to comply with fair labor standards and avoid penalties.

Is an employee legally entitled to retro pay?

‍Yes, employees are legally entitled to retroactive pay when an employer has made an error or failed to implement agreed-upon wage increases. Failure to provide retro pay can result in legal consequences under labor laws, such as the Fair Labor Standards Act (FLSA) in the U.S.