What Is a Direct Deposit?

What is direct deposit?

Direct deposit is a method of transferring money electronically from the payer to a recipient's bank account. The Automated Clearing House (ACH) is the network that processes these transactions.

If you get payments from a business or the government -- such as a paycheck, Social Security benefit, or dividend -- odds are good that they're sent to your bank account via direct deposit. As has been the case with other paper-based financial transactions, the humble check has been replaced by 1s and 0s zipping through the ether, which facilitate the transfer of funds from the payer to your account.

Direct deposit has its roots in the early 1970s, when the first ACH association was created in California. At the time, bankers were worried their technology would be unable to handle the growing tsunami of paper checks.

The National Automated Clearing House Association was created to administer a network for clearing transactions. The U.S. Air Force was the first employer to adopt the system, and Social Security started testing it in 1975.

An analysis by human resources and payroll provider Automated Data Processing (ADP +0.94%) found that $49.5 billion worth of checks were cleared in 1995; by 2020, the amount had plummeted to $11.2 billion. Fewer than 10% of U.S. employees received their pay via paper checks in 2019, ADP reported.

Federal law now requires all federal government payments -- except those made under the Internal Revenue Code, like tax fund refunds, hardship waivers, and emergency payments -- to be made via direct deposit. Besides paychecks and tax refunds, direct deposit is also commonly used for:

• Dividend payments
• Child support
• Social Security benefits
• Rental payments
• Vendor payments

How to set up direct deposit

Setting up direct deposit is generally a fairly easy task. Generally, if you want a paycheck sent directly to your account, your employer has a form with the required information. You'll need to provide:

• Employer name and address
• Your name and address
• Account type
• Account number
• Routing number

Many employers will also allow you to make deposits to multiple accounts. You can simply assign the percentage or dollar amount to be deposited to each. The paperwork can be different, but you'll need the same information to start direct deposits as you would for other types of payments, such as Social Security benefits, vendor payments, or rental income.

Pros and cons of direct deposit

After half a century, it's fair to say that direct deposit has become the transaction of choice for most recipients. Here are a few reasons for its popularity:

• Efficiency: Direct deposits are deposited directly into your account, with no intermediaries to gum up the works.
• Convenience: Direct deposit can save you a trip to the bank.
• Speed: Direct deposits are generally available instantly or within one business day.
• Security: Direct deposits are secure transactions that don't rely on documents that can be lost, stolen, or forged.
• Accuracy: Direct deposits are usually made with automated systems, such as a payroll or government benefits program, so there's less opportunity for error.
• Sustainability: Direct deposits don't require any physical media, such as paper, and only use a tiny amount of electricity.

That said, there are some potential downsides to direct deposit:

• Potential account compromises: A compromised bank account or stolen personal information can wreak havoc on your financial life (although that's also true of paper check payments).
• Occasional glitches: Bank systems can and do experience occasional outages and glitches.
• Setup process: Setting up a direct deposit can be a tedious and potentially error-prone process.

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