All of us are prone to make mistakes – it’s human nature, and employers are not exempt from such errors. However, if and when a mistake occurs while calculating payroll, and an employee’s compensation falls short of expectations, it can create a cascading wave of ill will. 

Regardless of the situation, everyone deserves to be paid what they’ve earned. Period.

Employers can resolve such an issue through retroactive pay – a mechanism designed to correct inadvertent missteps and provide employees with the wages they deserve. While retroactive pay serves as a way to right a wrong, it can also adversely affect a company’s culture, especially if employers deploy retroactive pay on a recurring basis. This article will examine both sides of that coin, showcasing the pros and cons of retroactive pay, how and when it should be deployed, and how time tracking software can help minimize any damage. So, without further avail, let’s dig in. 

What Is Retroactive Pay?

Retroactive pay refers to compensation that is paid to an employee for work or time that was performed in the past but was not properly compensated at the time it was due. Such an arrangement typically arises when an employer realizes an employee's pay was incorrect due to various factors, such as errors in payroll processing, missed wage increases, or adjustments to benefits. 

Retroactive pay is typically provided to rectify these oversights and ensure employees receive the full compensation owed to them. 

What’s the Difference Between Retroactive Pay and Back Pay? 

While the terms “back pay” and “retroactive pay” are similar, they’re not one and the same. 

As previously mentioned, retroactive pay refers to compensation adjustments made to reflect changes in pay rates or benefits retroactively. It may be provided when a pay increase or benefit change is implemented after the effective date, resulting in employees being owed additional compensation for the period between the effective date and the date of implementation. 

Back pay refers to compensation owed to an employee for work that was performed but was not properly compensated when it was due. It typically arises due to issues such as underpayment, missed wages, unpaid overtime, or wrongful termination. 

Back pay is often awarded as a result of a legal or administrative decision, such as a court ruling, arbitration decision, or labor settlement. It exists to make the impacted employee whole by providing him or her the wages he or she should have received but did not. 

According to the U.S. Department of Labor’s Wage and Hour Division, more than $26.9 million in unpaid wages were disbursed in 2023. 

Scenarios Leading to Retroactive Pay

Common occurrences that necessitate retroactive pay include: 

• Wage Increases: If an employer decides to raise the hourly wage or salary for certain employees, but the implementation of the new pay rates is delayed due to administrative reasons, retroactive pay may be provided to compensate employees for the period between the effective date of the increase and the date of implementation.

• Contractual Changes: Changes in employment contracts, collective bargaining agreements, or company policies that affect compensation -- such as modifications to overtime rates, shift differentials, or bonus structures -- may result in retroactive pay adjustments to ensure employees are compensated correctly for the affected period.

• Benefit Adjustments: Retroactive pay may be necessary when changes are made to employee benefits, such as health care coverage, retirement contributions, or paid time off (PTO) accrual rates, and these changes are applied retroactively, requiring adjustments to past pay periods.

• Arbitration or Legal Decisions: If an employer is found to have violated labor laws or contractual agreements, resulting in underpayment or wrongful termination of employees, retroactive pay may be awarded as part of a legal settlement, arbitration decision, or court ruling to compensate affected employees for past losses.

• Administrative Errors: In cases where administrative errors lead to incorrect calculation or disbursement of wages, bonuses, or other forms of compensation, retroactive pay may be provided to rectify the errors and ensure employees receive the correct amount owed for past work.
  
  
• Delayed Promotions or Reclassifications: If an employee is promoted or reclassified to a higher pay grade but experiences delays in the processing of the change, retroactive pay may be provided to compensate the employee for the difference in pay between the effective date of the promotion or reclassification and the date of implementation.

Calculating Retroactive Pay

Calculating retroactive pay can vary depending on the specific circumstances and type of compensation adjustments involved. Here are some detailed steps for calculating retroactive pay for different types of employees.

Hourly Employees - Wage Increase

1. Determine the effective date of the wage increase and the retroactive period for which retroactive pay needs to be calculated.
2. Obtain the employee's hourly wage rate before and after the increase.
3. Calculate the difference between the new wage rate and the old wage rate.
4. Multiply the difference in wage rates by the number of retroactive hours worked during the retroactive period.

• For example, Billy – a first-shift, hourly worker who works eight-hour shifts across five weekdays (40 hours per week) – received a $1 per hour pay raise on May 1, but the increase was not included in his paycheck covering the May 1 to May 13 pay cycle, so he was mispaid for 10 working days (80 hours). 
• To calculate the amount of retroactive pay Billy is owed, multiply the wage difference ($1 per hour) by the number of hours owed (80 hours). $1 x 80 = $80. 

Salaried Employees - Wage Increase

1. Determine the effective date of the salary increase and the retroactive period for which the retroactive pay needs to be calculated.
2. Obtain the employee's salary before and after the increase.
3. Calculate the difference between the new salary and the old salary.
4. Convert the salary difference to an hourly rate by dividing it by the number of work hours in the retroactive period (typically 40 hours per week).
5. Multiply the hourly rate by the number of retroactive hours worked during the retroactive period.

• For example, Sally, a salaried worker who earns $50,000 a year, received a 5% pay increase on Jan.1, yet both her biweekly paychecks for January did not include her increased wage rate. 
• First, you have to calculate her new salary. To do so, multiply $50,000 by 1.05 = $52,500.
• To calculate Sally’s hourly pay, divide $52,500 by 52 weeks. Then, divide that amount by 40 hours per week. ($52,500/52)/40 = $25.24.
• To calculate the number of unpaid hours in January, multiply 31 days by eight hours per day. 31 x 8 = 248 hours. 
• To calculate the retroactive pay owed, multiply Sally’s hourly rate by the number of hours worked in the month. $25.24 x 248 = $6,251.52. Thus, Sally is due $6,251.52 in retroactive pay.  

Shift Differentials

There’s a chance an employer issued a check that did not compensate an employee for extra money he or she may have earned by working separate shifts at different pay rates. To calculate a shift differential:

1. Determine the effective date of the shift differential change and the retroactive period.
2. Obtain the employee's base pay rate and the differential rate before and after the change.
3. Calculate the difference between the new differential rate and the old differential rate.
4. Multiply the difference in differential rates by the number of retroactive hours worked during the retroactive period.

• For example, Teddy, an hourly worker earning $15 per hour, earns an additional $2 per hour when he works the night shift. Teddy’s 40-hour workweek can be broken up into two unique shifts:
• Day shift: Monday to Friday, 12 p.m. to 4 p.m.
• Night shift: Monday to Friday, 11 p.m. to 3 a.m. 
• For the day shift, he works 20 hours at a rate of $15 per hour: 20 x $15 = $300
• For the night shift, he works 20 hours at a rate of $17 per hour: 20 x $17 = $340
• Add the two sums together to determine his adjusted weekly salary $300 + $340 = $640

Bonus or Incentive Adjustments

If a bonus wasn’t properly accounted for, here’s how to calculate the amount owed.

1. Determine the effective date of the bonus or incentive adjustment and the retroactive period.
2. Obtain the details of the bonus or incentive structure before and after the adjustment.
3. Calculate the difference in bonus or incentive amounts for the retroactive period.
4. Allocate the retroactive bonus or incentive amount based on the employee's performance or eligibility criteria during the retroactive period.

• For example, Jill is a salesperson whose bonus is calculated on her quarterly sales performance. She earns a 2% bonus on the total sales revenue she generates for each quarter. 
• In 2023, her quarterly sales revenue was:
• Q1: $100,000
• Q2: $120,000
• Q3: $110,000
• Q4: $130,000
• To calculate Jill’s quarterly bonus amounts, multiply each of the quarterly sales numbers above by 2% 
• $100,000 x 2% = $2,000
• $120,000 x 2% = $2,400
• $110,000 x 2% = $2,200
• $130,000 x 2% = $2,600
• To calculate Jill’s total annual bonus, add each of the quarterly figures together. 
• $2,000 + $2,400 + $2,200 + $2,600 = $9,200. Subtract the actual amount paid by the $9,200 figure to determine how much Jill is owed.

Benefit Adjustments

1. Determine the effective date of the benefit adjustment and the retroactive period.
2. Calculate the difference in benefit amounts for the retroactive period.
3. Allocate the retroactive benefit amount based on the employee's entitlement or usage during the retroactive period.

• For example, Andy earns a base salary of $50,000. He receives a health care benefit adjustment as part of his compensation package. Historically, the company has covered 80% of the monthly premium cost. However, the company recently announced it will increase its contribution to 85%, reducing Andy’s portion to 15%. 
• The current health care premium is $400. The adjusted premium, after the 5% increase, is $450. 
• To determine Andy’s savings, we have to calculate the employee contributions for both the new rate and subtract that from the previous rate. 
• 20% x $400 = $80
• 15% x $450 = $67.50
• To calculate the monthly savings in Andy’s paycheck, subtract the new contribution from the previous contribution. 
• $80 - $67.50 = $12.50. The company’s adjustments result in a savings of $12.50 per month. 

Legal Settlements or Arbitration Awards

1. Review the terms of the legal settlement or arbitration award to determine the retroactive pay owed to the affected employees.
2. Calculate the retroactive pay based on the specified compensation adjustments and retroactive period outlined in the settlement or award.

• For example, Sarah, a former employee of Acme Inc., filed a lawsuit against the company for wrongful termination. Both parties elected to settle the case.
• Compensation for lost wages: $50,000.
• Compensation for emotional distress: $20,000
• Punitive damages: $30,000
• Both parties agree to sign a nondisclosure agreement, preventing either the plaintiff or defendant from discussing the details of the settlement publicly. 
• The total settlement amount is the sum of each ($50,000 + $20,000 + $30,000) = $100,000. 

Legal Considerations and Operational Practices 

While there isn’t a specific federal law that universally dictates retroactive pay across all industries or situations, there are several federal laws and regulations that may require retroactive pay in certain circumstances. These include: 

• Fair Labor Standards Act (FLSA): Under the FLSA, employers are required to pay nonexempt employees at least the federal minimum wage and overtime pay for hours worked in excess of 40 in a workweek. If an employer fails to pay employees correctly for hours worked, they may be required to provide retroactive pay to make up for the underpayment.

• Equal Pay Act (EPA): The EPA prohibits wage discrimination based on gender for employees performing substantially similar work. If an employer is found to have paid employees of one gender less than employees of the opposite gender for equal work, they may be required to provide retroactive pay to rectify the wage disparity.

• Employment Contracts or Collective Bargaining Agreements: In some cases, employment contracts or collective bargaining agreements may specify conditions for retroactive pay, such as retroactive wage increases or bonuses. If an employer violates the terms of such agreements, they may be required to provide retroactive pay as specified in the contract or agreement.

• State Labor Laws: Some states have their own labor laws that govern retroactive pay, such as laws regarding wage and hour requirements, wage deductions, and payment of wages upon termination. Employers operating in these states must comply with both federal and state laws regarding retroactive pay.

Retroactive Pay’s Impact on Employee Morale and Trust 

Retroactive pay is a double-edged sword, meaning it can have both positive and negative effects on employee morale and trust depending on how it’s implemented and communicated.

Positive Impacts

• Recognition and Appreciation: Employees may feel valued and appreciated when they receive retroactive pay, as it acknowledges their contributions and efforts, potentially helping to boost morale.

• Trust in Employer: Timely payment of retroactive wages demonstrates an employer values fairness and transparency, enhancing trust between employees and management.

• Motivation: Retroactive pay can serve as a motivator for employees to continue performing well, knowing that their efforts will be recognized and rewarded.

Negative impacts

• Unfair Treatment: If retroactive pay is delayed or not adequately communicated, employees may perceive it as unfair treatment, leading to a decrease in morale and trust.

• Communication Breakdown: Poor communication about the reasons for retroactive pay or the process involved can lead to confusion and mistrust among employees.

• Is This the New Norm? If retroactive pay becomes a regular occurrence, employees may come to expect it as part of their compensation, leading to dissatisfaction if it is not provided in the future.

• Culture Shock: In cases where only certain employees receive retroactive pay (i.e., due to a union negotiation or pay adjustment), it can create tension and resentment among those who did not receive it.

Employers should ensure clear and transparent communication about the reasons for retroactive pay, the process involved, and the timeline for payment to mitigate potential negative impacts and maximize the positive effects of retroactive pay. 

Best Practices: Avoiding or Minimizing Retroactive Pay

Avoiding or minimizing retroactive pay requires proactive and strategic planning in several areas of human resource management. Here are some best practices:

• Regular Compensation Reviews: Conduct regular reviews of compensation structures and market benchmarks to ensure employees’ salaries remain competitive and aligned with industry standards. This proactive approach can help identify and address potential discrepancies before they necessitate retroactive pay adjustments.

• Clear Communication: Clearly communicate compensation policies, salary adjustments, and performance expectations to employees. Transparency about how salary decisions are made can help manage expectations and reduce the likelihood of surprises that could lead to retroactive pay situations.

• Performance Reviews and Merit Increases: Implement a structured performance review process that includes regular evaluations of employee contributions and achievements. Tie salary increases to performance, merit, and market adjustments rather than ad-hoc or reactive changes.

• Stay Updated on Legal and Regulatory Changes: Keep abreast of changes in labor laws, regulations, and industry standards related to compensation. This includes minimum wage laws, overtime regulations, and any other relevant legislation that could impact employee pay.

• Proactive Market Analysis: Conduct regular market analyses to ensure your organization's compensation packages remain competitive. By staying ahead of market trends, you can make timely adjustments to salaries, reducing the need for retroactive pay.

• Budgeting and Forecasting: Develop comprehensive budgeting and forecasting processes that account for potential salary adjustments. By strategically allocating resources and planning for future needs, you can proactively minimize the need for retroactive pay by addressing compensation issues.

• Training and Development: Invest in training and development programs to help employees enhance their skills and competencies. Employees who feel valued and supported are more likely to remain engaged and satisfied, reducing turnover and the need for retroactive pay due to staffing shortages.

• Regular Employee Feedback: Create channels for employees to provide feedback on compensation and other related matters. Actively listen to their concerns and suggestions, and incorporate their input into decision-making processes to foster a culture of transparency and trust.

• Negotiate Clear Contracts and Agreements: When entering into contracts or agreements with employees, ensure compensation terms are clearly defined and agreed upon by both parties. This can help prevent misunderstandings and disputes that might lead to retroactive pay demands.

Alleviate Retroactive Headaches with OnTheClock

Time tracking software can help prevent (or cure) any administrative headaches that retroactive pay may cause. OnTheClock, cloud-based employee time tracking and scheduling software designed to streamline workforce management for businesses of all sizes, can assist a company with retroactive pay by providing accurate time tracking and reporting features. If retroactive pay adjustments need to be made for employees, OnTheClock's reporting tools can generate detailed records of employee hours worked, including any overtime or missed punches. This information can then be used to calculate the correct amount of retroactive pay owed to each employee. 

Additionally, OnTheClock's payroll integration capabilities enable seamless communication between time tracking data and payroll processing systems, ensuring retroactive pay adjustments are accurately reflected in employee paychecks. Try OnTheClock free for 30 days. Come discover why more than 155,000 employees are using OnTheClock on a daily basis to optimize their time.