Everyone makes mistakes, and it happens every now and then that HR might make a mistake running payroll as well. If HR accidentally underpays an employee, the employee must of course be paid the money back. The same conundrum occurs when an employee's pay rate changes in the middle of their pay period.

To balance this discrepancy and avoid legal consequences, companies must give their employees retroactive pay to make them whole. But what exactly is retroactive pay, and how do you calculate it? 

This guide will tell you everything you need to know about retroactive pay and how to properly calculate it.

What is Retroactive Pay?

Also referred to as "retro pay," retroactive pay is the compensation an employee receives for work they've already performed in the past but weren't properly paid for. 

This can happen for a variety of reasons that result in a delay or discrepancy of payment for a period. To correct the difference and pay the money owed, a company must give retroactive pay to the employee.

Though you might also hear the term "back pay" in regards to retro pay, the two are slightly different: while retro pay refers to a discrepancy between money already paid and money owed, back pay refers to situations in which the employee wasn't paid at all for work done. 

If an attempt to pay the employee was made, then the term "back pay" is no longer applicable, and it'd be better to use "retro pay" instead. 

What Are Payroll Mistakes That Require Retro Pay?

Some common situations that would require retroactive pay are:  

1.Salary Adjustments

If an employee's salary is increased, retroactive pay may be provided to cover the period during which the employee was entitled to the increased salary but did not receive it. This salary increase might be due to a raise or promotion.  

2.Collective Bargaining Agreements

In unionized workplaces, when a new labor contract is negotiated and finalized, retroactive pay may be awarded to cover the period between the expiration of the previous contract and the implementation of the new one. 

This ensures that employees receive the agreed-upon wage increases or other benefits retroactively.  

3.Administrative Errors

If there has been an administrative error in calculating an employee's wages or benefits, resulting in an underpayment, retroactive pay is often provided to rectify the situation and compensate the employee for the shortfall. 

This may be because of an mistake in calculating overtime, a manual payroll error, or using the wrong rate when calculating the pay of an employee who works multiple positions.  

4.Legal Settlements

In certain situations, employers may be legally obligated to provide retroactive pay to employees as part of a legal settlement. This typically arises from cases involving labor law violations, discrimination, or other unlawful practices that impacted employee compensation.

Managing retroactive pay efficiently is crucial to ensure accuracy and compliance. An online free invoice generator can simplify this process by creating detailed invoices that clearly outline back pay amounts, periods covered, and adjustments. This transparency not only helps employers meet legal requirements but also builds trust with employees by providing clear documentation.

Using tools like invoice generators ensures retroactive pay is processed smoothly, minimizing errors and fostering a fair and compliant workplace.

How to Calculate Retroactive Pay

There are three ways to calculate retro pay, depending on how you originally pay your employee. If you balk at the sight of math or want to be sure no mistakes are made in your calculations, some websites online can help you accurately calculate retroactive pay.  

1.Flat Rate

The easiest retro pay to calculate is if you pay your employees a flat rate, such as for contract work for a specific job. The equation to calculate flat rate retroactive pay is simply to calculate the difference between the money paid and the money owed:

• Retro pay = (correct amount due - amount paid)
• So for example, if Sam was supposed to be paid $1,000 for his contract work but was only paid $750, his retro pay would be calculated as:
• Retro pay = (correct amount due - amount paid)
• Retro pay = (1,000 - 750)
• Retro pay = 250
• Sam would be owed $250 in retroactive pay. 

2.Hourly 

If your employee is paid on an hourly basis, here's how you calculate retroactive pay:

• Retro pay = (Correct hourly rate - Incorrect hourly rate) x (number of hours paid incorrectly)
• So for example, if you originally agreed to pay Jason $30 an hour but only paid him $25 for 10 hours, your retro pay calculation would look like this:
• Retro pay = (Correct hourly rate - Incorrect hourly rate) x (number of hours paid incorrectly)
• Retro pay = (30 - 25) x (10)
• Retro pay = 5 x 10
• Retro pay = 50

Jason's retroactive pay would be $50.

3.Salaried 

Retro pay for salaried employees is the most complicated to calculate, as it also depends on the number of times an employee is paid a portion of their annual salary per year (i.e. how many paychecks they receive per year), and how many of those paychecks were paid at an incorrect rate.

Salaried employees are usually paid either every week (52 pay days per year), two weeks (26 pay days per year), or monthly (12 pay days per year). With the knowledge of how many times you're paid per year, here's how you calculate retro pay:

Retro pay = (Correct salaried pay rate - Incorrect salary pay rate) / number of pay periods x number of pay days paid incorrectly

So for example, let's say Jessica originally has a $80,000 salary paid every two weeks, meaning she has 26 pay days per year. If Jessica got a raise to $85,000 that failed to appear in her last two payments, this is how she'd calculate her retro pay due:

• Retro pay = (Correct salaried pay rate - Incorrect salary pay rate) / number of pay periods x number of pay days paid incorrectly
• Retro pay = (85,000 - 80,000) / 26 x 2
• Retro pay = 5,000 / 26 x 2
• Retro pay = 384.62
• Jessica would be owed $384.62.

Wrapping up 

Retroactive pay is quite common for a variety of reasons, so it's important for those who run payroll to know how to calculate it ahead of time so they're not caught unaware. 

If retro pay isn't calculated or paid correctly, it could result in legal action and unhappy employees. 

That's why it's important for businesses to quickly correct any pay discrepancies and make employees whole with retroactive pay to keep the workplace running smoothly.