What is retro pay?

Imagine this: a team member opens their paycheck and notices something’s off. Payroll mistakes can happen whether it’s miscounted hours, an unaccounted raise, or an overlooked bonus. But how do you correct these errors? That’s where retro pay comes in. 

Short for retroactive pay, retro pay clears up discrepancies so your people receive the full amount they’re owed. Retro pay corrects oversights and gives your team members confidence in your compensation management. 

In this piece, we’ll explore what retroactive pay is, when to use it, and how to calculate it to keep your team happy and your business compliant. 

What is retro pay?

Retroactive pay, or retro pay, is compensation owed to a colleague for previous underpayment. There are plenty of reasons people don’t get their due pay, including delayed promotions, incorrect overtime calculations, and payroll system errors. 

Once the issue is identified, HR and payroll teams send retro pay in the next payroll cycle or as a special payment. 

Why is retroactive pay important? 

Retro pay is about maintaining fairness, building trust, and reducing legal risks—all of which contribute to satisfied people and a happier workplace. It helps HR and payroll teams: 

• Correct payroll errors: Payroll errors can lead to understandable dissatisfaction among your team. Solve this by addressing mistakes quickly and effectively before they impact retention. 
• Maintain pay increases on time: A raise recognizes a team member’s importance to the business. If you don’t immediately increase their salary, retro pay makes up for the difference. 
• Improve company culture: Efficient retro pay boosts company culture by fostering trust and fairness. When pay errors are quickly corrected, team members feel valued and confident that the company prioritizes their wellbeing. A happy workforce is more than just building a pleasant environment—it translates into a 13 percent increase in productivity. 
• Reduce compliance risk: Payroll compliance is complex. Manage compliance risks by understanding retroactive pay laws and addressing miscalculations as soon as possible.

When to use retro pay 

Let’s look at some of the most common scenarios for retro pay. 

Overtime pay 

When you miscalculate overtime hours or miss them entirely, recalculate the difference between standard and overtime pay rates. Multiply that by how many hours you missed and schedule a prompt retro payment. 

Wage increase

Forgetting to apply payment increases from raises and promotions happens. Retro pay offers a quick fix for delays in processing salary adjustments and provides a short-term solution while your systems catch up. A raise is a form of team member recognition, so retro pay ensures you reward your high performer from the date you say you will. 

Supplemental income

Retro pay may apply to supplemental wages, like bonuses and tips, that didn’t appear on the original paycheck. A great compensation strategy will create plans to pay supplemental income on time and retroactive payments can fix any oversight. 

Commission

Fluctuating salaries or commission structures can lead to payroll miscalculations.  If someone earns more commission than their paycheck states, HR teams can make retroactive adjustments to correct the mistake. 

Shift differential

Shift differential refers to the higher pay rate for people working during late shifts, weekends, or holidays. If your standard payroll processes overlook the premium rates, you can use retro pay to compensate for the differences. 

Payroll system error

Although payroll automation has significantly reduced the likelihood of payroll issues, mistakes can happen. Whether it’s system glitches or human error, quick, decisive fixes ensure team members receive the correct compensation and boosts trust in the payroll process.

How to calculate retroactive pay

Calculating retro pay isn’t just determining the difference between rates or hours—it  also includes applying accurate deductions and withholdings for tax purposes. 

Use this step-by-step guide to make reliable retroactive pay calculations. 

1. Determine the payment issue

Keep an eye out for the instances above, including promotions, payroll errors, or miscalculations. If a colleague reports they were underpaid, confirm the claims with all parties.

2. Establish the number of affected pay periods or worked hours

Determine the total number of hours or pay periods you missed paying your team member. This may span several pay cycles or a specific number of overtime hours. There’s no need to rely on memory.

Employee management software with time-tracking features can generate a clear, accurate picture of when and how much your people worked.

3. Calculate the difference

Compare what the team member was paid with what they should have received. For hourly people, multiply the missed hours by the correct rate. For salaried people, calculate the difference in their salary based on the missed adjustment.

4. Apply the necessary withholdings and deductions

Apply the appropriate tax withholdings, benefits, and deductions, just like regular wages. This keeps you compliant with tax laws and avoids any additional payroll errors.

5. Issue the retro pay

Once you’ve calculated the correct amount, add it to the person’s next paycheck. This lump-sum payment will correct the underpayment and provide compensation. In some cases, you can issue an on-demand payment to resolve the issue before the next payroll cycle. 

Clearly label the payment so the team member knows it’s retroactive compensation.

Differences between retro pay and back pay

Retro pay and back pay both involve compensation for previous work, but they fix different payroll errors. 

Example of retro pay

Retro pay typically involves small, corrective adjustments within a payroll cycle. Let’s say Sam got a promotion in January, but due to a payroll system error, his salary wasn’t adjusted until March. Sam asks an HR professional about the error, who schedules the retro pay, compensating Sam for the difference over the eight weeks.

Back pay example

Back pay applies when someone receives nothing for the hours they’ve worked, such as wages withheld due to a legal dispute or missed payments during employment. Back pay often involves larger payments owed for multiple pay periods or long-standing compensation issues.

Let’s look at a different example. Alex was laid off but later won a legal dispute for wrongful dismissal. The court ordered the business to provide back pay for the three months they didn’t pay Alex, covering the entire salary Alex would have received without the wrongful termination. The back pay also includes missed benefits or bonuses Alex would have received during that time. 

Retro pay best practices  

Here are some extra tips so you can successfully provide retro pay for your people.

1. Communicate clearly

As soon as you identify a payroll error, inform the affected person about the issue and explain how you’ll correct it. Provide a timeline for receiving the retro pay to keep your colleague feeling valued and informed. This helps maintain organizational trust and reassures your entire team you address payroll mistakes promptly and fairly.

2. Prepare to answer questions and avoid withholding information

Schedule a brief meeting to go over any questions your colleagues may have. Clearly explain the nature of the payroll error and come clean if it’s due to human error.  Be prepared to explain the calculations, determined adjustments, and payment timeline. 

Clarify next steps and let team members know who to contact with any additional concerns, ensuring they feel supported throughout the process.

3. Compensate everyone accurately

Double-check all calculations, including base wages, overtime, bonuses, and other pay components, so the retroactive compensation reflects exactly what each person earns. 

Try payroll automation tools to help streamline these calculations and reduce the risk of future errors. Automated payroll systems ensure that raises, overtime, and other pay changes are applied accurately and on time.

Seamlessly manage your retro pay

Retro pay is more than just correcting payroll errors—it’s about maintaining trust and transparency with your team. When handled efficiently, it shows your commitment to fair compensation and ensures payroll issues don’t disrupt your people’s morale or financial wellbeing. 

By automating payroll processes, businesses can reduce manual errors, improve compliance, and provide timely retro pay—all of which contribute to a more efficient and reliable payroll experience for your team.

Download our pay equity template to ensure accurate, equitable pay across your organization and show your team they’re truly valued.

<<Use this pay equity template to support a fair and equal workplace.>>