What is Retroactive Pay?

December 4, 2023
Retroactive pay

Retroactive pay (or retro pay) is when compensation is due to an employee for work they already performed.

What retro pay is, and how to calculate it

In a prior pay period, did you pay an employee less than what they should have received? If so, the employee is due retroactive, or retro, pay.

Retro pay meaning

US Legal defines retroactive pay as “a delayed wage payment for work already performed at a lower rate.”

Retro pay may stem from:

  • Pay increases. For instance, an employee received a raise, which they should have gotten 2 pay periods ago.
  • Payroll error, such as entering the wrong wage information into the payroll system.
  • Incorrect overtime wages. Under federal law, employees who work more than 40 hours in a workweek must receive overtime pay at 1.5 times their regular hourly rate. If you paid the overtime hours at the employee’s regular rate instead of their overtime rate, the employee is due retro pay.
  • Inaccurate compensation for other types of pay — such as bonuses, commissions, and shift differential.

Remember, to be owed retro pay, the employee must have been paid the incorrect amount. This is in contrast to back pay, which refers to wages owed because they were never paid.

How to calculate retro pay for hourly and salaried employees

Hourly Example

Sarah received a pay increase, from $13 to $14 per hour, which should have taken effect 2 biweekly pay periods ago. For those 2 pay periods, Sarah worked, and was paid for, a total of 160 hours (80 hours per biweekly pay period).

To do the calculation, you need the:

  • Old hourly rate
  • New hourly rate
  • Effective date for the pay increase
  • Number of work hours paid at the old rate

Sarah’s retro pay calculation:

  • $14 per hour – $13 per hour = $1 per hour, difference in her old and new rates
  • 160 hours X $1 per hour = $160, retro pay owed to Sarah

If Sarah had worked overtime, her retro pay would include overtime wages based on the difference in her old and new overtime rates.

Salaried Example

Mike received a salary increase of 5%, from $55,000 per year to $57,750 per year, which was effective in the last semi-monthly pay period.

To do the calculation, you need the:

  • Old annual salary
  • New annual salary
  • Difference in the old and new salaries
  • Effective date for the salary increase

Mike’s retro pay calculation:

  • $55,000 / 24 (number of semi-monthly pay periods for the year) = $2,292; old semi-monthly salary
  • $57,750 / 24 = $2,406.25; new semi-monthly salary
  • $2,406.25 – $2,292 = $114.25, difference in the old and new semi-monthly salaries
  • $114.25 x 1 semi-monthly pay period = $114.25, retro pay owed to Mike

Retro pay taxes

As the employer, you must withhold employment taxes from the employee’s gross retro pay, including:

  • Federal income tax
  • Social Security tax
  • Medicare tax
  • State and local income taxes, if applicable

You must also pay your own share of applicable employment taxes on the retro payment. Note that the IRS regards retroactive pay increases as supplemental wages, which are wages paid in addition to regular pay. See IRS Publication 15 for details on withholding federal taxes from supplemental wages. States have their own income tax withholding rules for supplemental pay.

Legal considerations

According to LegalMatch, an employee may be legally entitled to retro pay if their employer:

  • Unlawfully gave retroactive pay increases to only a select group of employees (in other words, discrimination)
  • Breached the employment contract by withholding the employee’s wages
  • Retaliated against the employee for being a whistleblower, by withholding their retro pay

For these reasons, and to keep employee morale high, be sure to administer retro pay in a fair and accurate manner.

What Is Retroactive Coverage?

Employees have 30 days from their projected effective date to enroll in health insurance coverage.

If the employee enrolls in coverage on day 29 beyond their effective date, their coverage will be retroactive to their effective date. In other words, the first day of coverage is actually in the past.

For example, if an employee’s effective date is 3/1 and the application isn’t processed by the carrier until 3/15, the employee’s coverage is retroactive to their original 3/1 effective date.

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