What Is Retro Pay, and How Does It Work? 

“You don’t mess with people’s pay,” noted Yekaterina Weaklim, interim HR consultant at Korn Ferry — who also noted that sometimes mistakes happen. “It’s often because of human error, but employers have a responsibility to correct these mistakes as soon as possible.” 

Retroactive pay, or retro pay, is the mechanism by which employers rectify pay discrepancies to ensure employees receive the compensation they’re rightfully owed when errors occur. Below, we cover all aspects of retro pay — including what it is and when it’s needed, calculation examples, and compliance responsibilities as an employer — and offer a downloadable payroll checklist.  

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Retroactive Pay 101

Retroactive pay is compensation owed to employees for work that was already performed but incorrectly paid. Unlike a bonus or incentive, retro pay isn’t additional compensation but rather a correction to ensure employees receive their proper wages. For employers, retro pay serves as a mechanism to rectify payroll errors, implement delayed pay changes, and maintain compliance with wage laws.

“Retro pay can be needed due to an error on the company's part, where they underpaid or even overpaid an employee in a previous paid period. Or it could also be an error on the employee's part, for example, if they’re an hourly employee who forgot to clock in and out on a certain day,” said Melissa Puopolo, fractional human resources manager at Atomus Partners, an HR consulting firm for small and mid-sized businesses.

Retro Pay vs. Back Pay

As a note on wording, some resources differentiate between back pay and retro pay, while others do not. Where distinguished, retro pay is categorized as an underpayment due to an administrative delay or other good faith error, while back pay corrects for a failure to make any payment and may signal a wage violation.

The Fair Labor Standards Act (FLSA), which establishes and regulates pay requirements in the US, can be used to pursue certain wage discrepancy claims. The US Department of Labor (DOL) enforces the FLSA and simply uses the term back pay, explaining, “A common remedy for wage violations is an order that the employer make up the difference between what the employee was paid and the amount he or she should have been paid. The amount of this sum is often referred to as ‘back pay.’”

Always let the employee know what happens, what was affected, and how much they’ll receive.

When Retroactive Pay Is Needed

Several scenarios trigger the need for retro pay, which is more commonly needed for hourly employees than for salaried employees. “Salaried employees are always paid the same amount, so there’s less likelihood for an error,” said Puopolo. 

Some of the most common reasons for retroactive pay include the following:

• New Hire Timelines: When new hires join in the middle of a pay cycle, retro pay is used to make up for the days worked between their hire date and first paycheck.
• Delayed Raises and Promotions: When salary increases are approved after a pay period has begun, retro pay bridges the gap between the effective date and implementation date.
• Overtime Miscalculations: Retro pay corrects errors if overtime hours were calculated incorrectly or overlooked entirely.
• Payroll Errors: Simple payroll mistakes like data entry errors or incorrect pay rates require retro pay corrections.
• Incorrect Shift Differentials: Failure to include premium pay for night shifts, weekends, or holidays often requires retroactive correction.

“Many of these errors happen because companies don’t have a proper payroll checklist or fail to use a robust payroll solution,” said Weaklim. 

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How to Calculate Retroactive Pay

The method for calculating retro pay depends on the employee’s pay structure and the nature of the discrepancy. While your payroll solution or a retro pay calculator can do the math for you, it’s important for HR to understand the process.

📌 For Hourly Employees

1. Calculate the difference between the correct and incorrect hourly rates.
2. Multiply by the number of hours worked during the affected pay periods.

Example: An employee who worked 80 hours over two pay periods was paid $18/hour instead of their recently approved $20/hour rate.

• Rate difference: $20 - $18 = $2/hour
• Hours worked: 80 hours
• Retro pay owed: $2 × 80 = $160

✅ For hourly employees, it’s important to double-check for overtime wages. Let’s look at another example. 

Example: An employee worked 84 hours over two pay periods but was only paid for 80 hours.

• Hours actually worked: 84 hours
• Hours paid: 80 hours
• Missing hours: 84 - 80 = 4 hours

During the next pay period, they worked 76 hours. When processing the retro pay:

• Regular hours for current period: 76 hours
• Retro hours owed: 4 overtime hours
• Total hours to process: 76 regular hours + 4 retro overtime hours

📣 The 4 missing hours must be paid at the applicable overtime rate, not at the regular rate, as they were overtime hours in the original pay period. Don’t simply add them to the current period’s regular hours, as the payroll system might not automatically apply overtime rates to these retro hours.

If the employee's hourly rate is $20/hour with an overtime rate of $30/hour:

• Current period regular pay: 76 hours × $20 = $1,520
• Retro overtime pay: 4 hours × $30 = $120
• Total payment: $1,640

📌 For Salaried Employees

The calculation involves prorating the salary difference over the affected pay periods:

1. Determine the annual salary difference.
2. Divide by the number of pay periods per year.
3. Multiply by the number of affected pay periods.

Example: A salaried employee’s annual compensation increased from $60,000 to $66,000, effective two pay periods ago. With biweekly payroll (26 pay periods annually):

• Annual difference: $66,000 - $60,000 = $6,000
• Per-period difference: $6,000 ÷ 26 = $230.77
• Retro pay owed: $230.77 × 2 = $461.54

Example: A new hire joins in the middle of a payroll cycle. As a salaried employee, they need to be paid based on the days they have worked.

Weaklim said HR often incorrectly calculates this by converting salary to an hourly rate, then multiplying by 8 hours per day and number of days worked. Rather, they should convert the annual salary to a daily rate and go from there: 

• Annual salary: $60,000
• Monthly salary: $60,000 ÷ 12 (number of months) = $5,000
• Working days in the month (e.g., April has 22 working days): 22 days
• Daily rate: $5,000 ÷ 22 = $227.27 per day

Calculate prorated pay:

• If the employee worked 9 days in the month
• Prorated pay: $227.27 × 9 = $2,045.43

📝 Keep in mind that the daily rate varies each month based on the number of working days in that specific month. Using a fixed hourly rate × 8 hours would incorrectly assume all months have the same number of working days, Weaklim explained. 

This approach ensures that the employee receives the correct proportion of their monthly salary based on actual working days in that specific month.

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Compliance and Legal Considerations

Like almost all compliance matters in HR, retroactive and back pay are governed by various federal and state wage laws. 

Fair Labor Standards Act (FLSA): While the FLSA doesn't explicitly mandate timelines for paying retro wages, back pay guidance from the DOL, which oversees and enforces the FLSA, indicates that corrections should be made promptly.

State Laws: Some states have specific requirements for addressing wage discrepancies. This is more common in the case of back pay, where potential wage violations have occurred, versus retro pay, which is often the case of misalignment between events that trigger pay changes and a payroll period. 

Statute of Limitations: As explained in the DOL back pay guidance, claims for unpaid wages typically have a two or three-year statute of limitations under federal law, depending on whether the violation was willful. State laws may provide longer periods for employees to file claims.

Documentation Requirements: As Puopolo suggested, “Document, document, document.” Employers must maintain detailed records of wage calculations, adjustments, and communications regarding retroactive pay.

Employee Communication

Clear communication is essential when processing retroactive pay. “Always let the employee know what happens, what was affected, and how much they’ll receive,” said Puopolo. 

Weaklim added that it’s helpful to let employees know in advance if they’re going to fall outside of a pay cycle, like for new hires. Some other best practices include the following: 

• Provide a written explanation. Detail the nature of the error or adjustment, the time period affected, and how the correction was calculated.
• Use clear paystub notation. Ensure retro payments are clearly labeled on paystubs, with separate line items if possible.
• Be available for questions. Designate specific personnel to address employee inquiries about retro pay adjustments.
• Document everything. Maintain records of all communications regarding the retroactive payment.

Errors happen the most when people or companies aren’t tracking or didn't have a proper payroll checklist.

Compliance Challenges

Managing retroactive pay presents several challenges for employers:

• Complex Calculations: Determining the correct amount can be complicated, especially when multiple pay rates, overtime, or benefit changes are involved.
• Multiple Systems Integration: Without integrated solutions, coordinating between HRIS, timekeeping, and payroll systems to ensure accurate data for retro calculations presents challenges.
• Historical Data Access: Accessing and verifying historical pay records can become difficult, particularly when systems have changed.
• Compliance Variations: Navigating different requirements across jurisdictions creates additional complexity for multinational or multistate employers.

“Errors happen the most when people or companies aren’t tracking or didn't have a proper payroll checklist just to make sure that everybody was captured,” said Weaklim. 

These challenges highlight why many companies opt for specialized payroll software that can automatically calculate retroactive pay while ensuring compliance with applicable laws.

Best Practices for Managing Retroactive Pay

Staying organized and compliant with retroactive pay doesn't have to be overwhelming. Follow these best practices to streamline the process:

⚠️ Monitor proactively. Regularly audit payroll processes to identify and correct errors before they accumulate. Conduct spot checks on payroll calculations, especially after system changes or updates.

✍🏽 Document everything. Maintain detailed records of all compensation adjustments, including effective dates, approval documentation, and communication with affected employees. The best payroll systems allow you to make a note directly in the solution, but if not, Puopolo recommends HR folks keep a “payroll journal” in a spreadsheet for each payroll they run. 

🕑 Prioritize timely corrections. Address underpayments promptly to maintain employee trust and minimize potential penalties or interest. “Best practice is and should be to run a mid-cycle payroll or adjustment to rectify the discrepancy right away. You never know if someone's living paycheck to paycheck,” said Puopolo.

👩🏾‍💻 Leverage technology. Utilize payroll software that automates complex calculations and maintains detailed audit trails for retroactive adjustments.

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