Retro Pay

Retro pay, also known as retroactive pay, is additional compensation provided to an employee to correct an underpayment that occurred in a previous pay period. This underpayment may arise from various reasons, such as payroll errors (e.g., incorrect pay rates or missed overtime), delayed implementation of salary increases, or miscalculations of supplemental income like bonuses or shift differentials. Importantly, retro pay differs from back pay, which compensates employees for periods where no payment was received at all. Instead, retro pay specifically addresses instances where payment was made but was insufficient according to the correct rate or terms.

For example, if an employee was entitled to a raise starting January 1st but the payroll system was not updated until March 1st, they would receive retro pay to cover the difference between their old and new salary rates for January and February. Similarly, if overtime hours were not correctly multiplied by the overtime rate, the shortfall would be rectified through retro pay.

What Are Some Examples of Retroactive Pay?

There are a few different reasons why an employee might be entitled to retroactive pay. Some examples include:

• Delayed pay increases: An employee receives a salary raise effective from a specific date, but due to administrative delays, the new rate is not applied until later. Retro pay covers the difference for the periods where the employee was paid at the old rate.
  • Example: An employee’s hourly rate increases from $20 to $22, effective two pay periods ago. The difference of $2 per hour for the hours worked in those periods is added as retro pay in the next paycheck.
• Overtime pay miscalculations: Overtime hours are not compensated at the required rate (e.g., 1.5 times the regular rate). Once discovered, the employer issues retro pay for the underpaid amount.
  • Example: An employee worked 10 overtime hours at $15 per hour instead of the correct $22.50 per hour. Retro pay of $75 (10 hours × $7.50) is issued.
• Payroll processing errors: Mistakes in entering wage rates, forgetting shift differentials, or other payroll inaccuracies result in underpayment. Retro pay corrects these errors.
  • Example: An employee entitled to a shift differential for night shifts was not paid the additional rate for several pay periods. Retro pay is calculated and added to the next paycheck.
• Global payroll issues: In international payroll, errors such as currency conversion mistakes or misapplication of local pay rates can lead to underpayment. Retro pay corrects these discrepancies.
  • Example: A contractor in Brazil was paid based on an incorrect USD to BRL exchange rate, resulting in underpayment. Retro pay is issued to make up the difference once the error is identified.
• 13th-Month salary adjustments: In countries where a 13th-month salary is mandatory (e.g., Philippines, Mexico), if it is not paid on time or is calculated incorrectly, retro pay may be required to adjust for the shortfall.
  • Example: In the Philippines, an employee is entitled to a 13th-month pay. If the employer fails to include it in the December paycheck, retro pay might be needed if the payment is made in January.
• Commission or bonus miscalculations: Sales commissions or performance bonuses underpaid due to calculation errors or delays in customer payments require retro pay to ensure employees receive their full entitlement.
  • Example: A salesperson earned commissions on sales closed in a previous quarter, but due to late customer payments, the commissions were not included in the correct pay period. Retro pay is issued once the funds are available.

How To Calculate Retroactive Pay?

Calculating retroactive pay involves determining the difference between what the employee was originally paid and what they should have received. 

This calculation differs depending on whether you need to pay retroactive pay to a salaried employee, or to workers being paid an hourly rate.

Calculating retro pay for salaried employees

For example: A salaried employee received an increase of 10%, taking their annual salary from $75 000 to $82 500. They were supposed to start receiving their new salary two months ago, but they’ve continued to receive their original salary in error.

To calculate their retro pay, you have to know:

• Their previous annual salary ($75 000)
• Their new annual salary ($82 500)
• The effective date of the new annual salary 

Next, follow these steps:

• Calculate their original monthly salary: $75 000 divided by 12, which is $6 250
• Calculate their new monthly salary: $82 500 divided by 12, which is $6 875
• Calculate the difference between the two monthly salaries by subtracting the previous monthly salary from the new monthly salary: $625
• Multiply this number by the period affected by missed payments, in this case two months. 

Therefore, the salaried employee will receive $1 250 in retro pay.

You should also take into account any requirements around remuneration that might affect your calculations in a specific region. For example, in some countries 13th month salaries can form part of an employee’s annual base salary - in this case, you would divide by 13 to get the monthly salary amounts.

Calculating retro pay for hourly employees

For example: An hourly employee should have received a raise from $14 to $16 two weeks ago, and is paid weekly. During this time, they’ve worked 90 hours in total.

To calculate their retro pay, you have to know:

• Their previous hourly rate ($14)
• Their new hourly rate ($16)
• The effective date of their raise
• The number of hours they worked at their previous hourly rate, since the new rate should’ve taken effect (90 hours in this example)

Next, follow these steps:

• Calculate the amount the hourly rate increased ($2 in this example)
• Multiply the hours they worked at their previous hourly rate by the hourly increase: 90 x $2.

Therefore, this hourly employee will receive $180 in retro pay.

The total retroactive pay is added to the employee’s next paycheck or issued as a separate payment, with applicable taxes and deductions applied. 

What Is The Difference Between Retroactive Pay And Back Pay?

Retroactive pay and back pay are often confused, but they serve different purposes. Retroactive pay refers to adjustments made for discrepancies within the same role, such as missed raises or incorrect pay rates. 

Back pay, on the other hand, is typically awarded due to legal disputes, such as unpaid wages for work performed or compensation owed due to wrongful termination. While both involve compensating an employee for unpaid wages, back pay usually results from a legal ruling or settlement, whereas retroactive pay is a correction of prior payroll processing errors.

The primary difference between retroactive pay and back pay lies in the nature of the payment:

• Retroactive Pay: Addresses underpayment, where the employee was paid but received less than they were entitled to. It corrects payroll errors like miscalculated wages, delayed raises, or overtime miscalculations. For example, if an employee was paid $15 per hour for overtime instead of the correct $22.50 per hour, retro pay of $75 for 10 hours would be issued.
• Back Pay: Compensates for unpaid wages, where the employee received no payment at all for work performed. This could occur if an employee worked 40 hours but received no paycheck due to a payroll system failure, or if a court orders back pay for unpaid overtime in a wage violation case.