How Does Direct Deposit Work?

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Updated on Monday, February 11, 2019

There’s a mathematical notion that the shortest distance between two points is a straight line. A good example of that adage is direct deposit, which links a payment check directly to an individual’s bank account. We’ll cover what direct deposit is and how it can simplify your financial life in this post.

What is direct deposit?

By definition, direct deposit is the electronic transmission of a payment to the payee from the payer, directly into the recipient’s bank account.

Banks and other financial institutions depend on the Automated Clearing House (ACH) network to transmit funds back and forth. That’s why you may see the term “ACH deposit” on your payment confirmation from your bank.

Who uses this method of payment? The better question is, who doesn’t? Consider these examples:

  • Employers use this to distribute paychecks to employees, thus avoiding the multiple day delay deposit wait that comes with receiving paper checks by mail.
  • Businesses use this method of payment, too. Think of a brokerage company sending a payment to an investor via direct deposit.
  • The government favors direct deposit, as well. For example, the Internal Revenue Service sends tax refunds to a taxpayer straight into his or her bank account, as does the U.S. Social Security Administration, which sends Social Security checks to retirees via direct deposit.
  • Individuals use this for private transactions directly from one bank account to the other. Think of a parent sending money to a son or daughter in college, or a renter sending a monthly payment to a landlord.

In terms of convenience and speed, it’s tough to beat this method of payment. All you have to do is set it up, track your transactions and never worry about waiting for a check in the mail again. Plus, you avoid bank check fees, as well.

How to up direct deposit in 5 steps

For the purposes of this demonstration, let’s assume you want to set up direct deposit with your employer. Here’s what you need to do.

Step #1: Contact your employer and request a direct deposit form. Chances are your employer has either a physical form to fill out or a form to fill out online. If your employer can’t provide a sign-up form, either the employer’s bank or your bank can provide a form for you.

Step #2: Complete the account information. Review the form and complete it. It varies by bank or employer, but you may need the following information to get the job done:

  • Your bank’s physical address. Find this on the financial institution’s website.
  • Your bank’s routing number. This is the nine-digit number on the bottom left of your check used for the transmission of electronic payments.
  • Your bank checking account number. Your bank checking account number can also be found on the bottom of your check to the right of your routing number. Or, you can find it on your bank statement.
  • Your Social Security number. Your employer will likely need your Social Security number to set up your taxable account with the IRS.
  • Your name, home address or email address. Your employer and your bank may need your name and address to send confirmation notices. These days, confirmation notices are mostly transmitted online.
  • A voided check. Your employer may request a cancelled or voided check to confirm your bank account information. This may require your scanning a copy of your check and sending it to your employer online. Or, just give a physical copy of a cancelled check to your employer with your form. Simply write “VOID” across the check before sending it to your employer, which ensures the check is unusable.

For more detail, here’s a sample direct deposit form from Wells Fargo.

Step #3: Decide where the money will be sent. Normally, direct payment recipients request that their payments go straight into their checking accounts. That said, you do have options. You can either have 100% of the check transmitted into your checking account, or “split” the direct deposit, with, for example, 90% of the payment going into your checking account and 10% going into your savings account. Some employers or banks may allow you to direct deposit into more than two bank accounts.

Step #4: Submit your paperwork. Once you’ve filled out the form and decided where the payment will go, send your paperwork to your employer, who will set up the direct payment with your bank. This process usually only takes a few days, but it may take longer, depending on your employee’s payroll practices. To be sure, ask your employer how long it takes for your direct deposit payment to be set up.

Step #5: Track your account. Keep an eye on your account to see when the payment hits, and that it’s the correct amount. You can request free alerts from your bank or payment provider (like PayPal or Venmo) to give you a heads-up when your payment will hit your account.

Pros and cons of direct deposit

There are benefits and some disadvantages to direct deposit:

Pros:

  • It is highly convenient. No more waiting for a paper check to arrive in the mail and then depositing into your bank account
  • Payment is fast – usually one business day from the time the employer submits the payment, although payments can be as fast as the same business day, too.
  • It’s safe. Banks and credit unions go to great lengths to make your direct deposit safe, deploying firewalls and data security measures to ensure your funds can’t be intercepted or stolen. Additionally, you won’t have to worry about a paper check being lost or stolen in the mail.

Cons:

  • Potentially high fees. You don’t have to have a bank account to set up direct deposit, but it sure does help. Employers or the government may offer direct deposit on prepaid cards or payroll cards which tend to trigger higher fees since you’re using a card to access your money all the time. Plus, if you lose the prepaid card, it can take some time to get you a new card.
  • Changing banks. If you change banks or credit unions, handling all the new paperwork can be a hassle.
  • It’s too convenient. It can be so convenient that you stop monitoring your paystubs or checking your payment to see if it’s accurate.

The bottom line: Direct deposit is definitely worth the initial hassle

By and large, this is a fast, safe and convenient way to transmit and receive payments. Check with your employer and/or your bank for more information on how direct deposit can work best for you.

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