How does an ACH deposit work? A behind the scenes look

Roughly 93% of Americans receive their pay by what is commonly known as direct deposit—a payment method that runs off the ACH network. ACH transactions are the unsung hero in the financial plumbing in the US, responsible for nearly $77 trillion in payments in 2022. 

The Automated Clearing House (ACH) system has become a crucial component of the modern financial landscape. This guide explores the workings of ACH, including how it has revolutionized the way payroll is processed and the differences between ACH transactions and real-time payments and electronic funds transfers (EFTs). Finally, we'll turn an eye to the future and explore how innovations in the financial world may impact ACH usage.  

What is an ACH deposit?

An ACH deposit is a credit payment made using the Automated Clearing House (ACH) network—i.e., the inter-bank system used by 12,000+ member institutions to coordinate funds transfer requests between bank accounts under their control. ACH is used for a variety of transaction types including payroll, bill payment, and peer-to-peer payments. 

How does ACH work? 

ACH payments begin when the sender initiates an ACH transaction, often through their bank or financial institution. When a credit payment is sent, it is often referred to as an ACH deposit. When a payment is withdrawn from an account, it is called an ACH debit.

The sender provides the required information, including the routing number, bank account number, and the amount to be deposited to or withdrawn from the recipient’s account. 

The financial institution then transmits the ACH file to an ACH Operator, which facilitates the exchange between the two banks. Many organizations use Plaid Signal to determine the risk of potential ACH returns and fraud. 

This is the core of how ACH works. However, there are several different use cases for ACH, whether you're receiving your paycheck through ACH or paying your utility bill. 

How do ACH direct deposits work? 

ACH direct deposits allow companies to pay their employees directly to their bank accounts, eliminating the need for paper checks. ACH direct deposits move money from the employer's bank account to an employee’s in an easy and relatively inexpensive way. The employer simply asks their financial institution (or payroll company) to instruct the ACH network to pull money from their account and send it to the employee's bank account. 

Government agencies also rely on ACH direct deposits to send tax refunds, social security payments, and unemployment benefits. 

For a deeper look at how ACH transfers technically work, check out our article, “How an ACH transfer works”.

What are the benefits of using ACH for payroll? 

Using ACH direct deposits for payroll offers several advantages to both businesses and employees. These payments are cost-effective, as the cost to process ACH is only a few cents in most cases. It also eliminates the need for paper checks, postage, and manual processing. 

They are also reliable and convenient—employees no longer need to remember to pick up a check and make it to the bank before closing time. ACH for payroll is also a more secure method for paying employees, as there's no chance for a bad actor to steal the check. 

What’s an ODFI or RDFI in ACH deposits?

ODFIs (Originating Depository Financial Institutions) are the financial institutions that initiate an ACH transaction on behalf of their customer, or the ACH sender. They are responsible for protecting ACH security and reducing ACH returns. RDFIs (Receiving Depository Financial Institutions) are the institutions that accept ACH deposits. They are responsible for accepting and validating ACH deposits. Depending on the transaction, the ODFI and RDFI can be the same financial institution. 

It’s also common for third-party senders to operate between originators and ODFIs. A company that wants to use ACH for payroll, for example, is an originator. In many cases, their payroll processor has an agreement with a bank (the ODFI) to transmit those files to the ACH network and acts as a third-party sender on behalf of the company.  

From the network’s perspective, ODFIs and their processing partners are the digital post offices through which bundles (or “batches”) of ACH transactions come in. These batches are then processed by one of the two ACH network operators, at whose clearinghouses the individual messages are rebundled according to their destination. While RDFIs sometimes send back error messages called ACH return codes, the ODFI is always the first to start the exchange. 

Both ODFI and RDFI play crucial roles in the ACH deposit process. The two institutions (or two arms of the same institution) facilitate a secure, efficient, and accurate transfer of funds. 

How do ACH deposits compare with checks?

The end result of an ACH deposit and a paper check is the same—once the transaction is complete, money is moved from one account to another. However, there are distinct differences between automated clearing house deposits and checks, including cost and how they are processed. 

Paper checks involve more processing steps, and therefore more administrative expense. The average cost of ACH payments is between $.15 and .25, while paper checks cost between $2 and $4, due to administration costs and financial institution fees. Checks are also more inconvenient: the payer needs their checkbook handy, the payee needs to accept the check, there is often mailing involved, and checks can be lost, stolen, or forged. The receiver will need to head to the bank or use a banking app to deposit the funds. 

ACH deposits, however, are processed digitally. There is no need for a check, no risk of the check being stolen, and no waiting for a check to clear your account. Traditional ACH deposits can take several days to process. However, same-day ACH is making the process even easier by allowing ACH to process faster.

Are ACH deposits and eChecks the same thing?

Informally, eChecks are paper checks that have been manually converted into ACH debit requests, where the information has been digitized and the check archived or destroyed. However, the term can also represent the idea of ACH transactions as "a digital replacement for the paper check", where no physical check is ever used.

Many mobile banking apps let customers capture paper checks via their phone’s camera. Those apps might then strip the relevant info and create ACH requests, or they might just forward the digital scans to a traditional check-clearing facility. 

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How long does an ACH deposit take?

A typical ACH deposit takes anywhere from a few hours to a few days to be delivered to the RDFI. The speed depends on when the transaction was initiated, whether the originator opted for expedited service and whether the transaction returned an error code. 

Since March 2021, ACH messages have been delivered 6 times per business day, which allows for faster processing. Same-day processing is also available for a small additional fee (typically about $0.05).

While error codes are less of an issue with credits/deposits than debits (where insufficient funds are more likely), credit transactions can still be returned for wrong account or routing numbers or closed accounts. These mistakes can lead to a delay of an extra day or two while the banks determine if the transaction can be salvaged.

Not factoring in errors/returns, a standard ACH transaction follows this timeline:

What’s the difference between ACH and EFT?

The Automated Clearing House (ACH) network is one specific protocol for moving funds between financial institutions. EFT, or Electronic Funds Transfer, is an umbrella term that includes ACH transactions, wire transfers, and other types of digital payments.

While the most cost-effective, ACH is also the slowest EFT solution, as its messages are sent in batches to the network to be sorted and repackaged for delivery several times per business day. Also, ACH can’t show whether a given transaction will clear in real time, while others can.

This distinction is narrowing though, as new solutions built on top of ACH allow for features formerly available only through other EFT types. For example, Plaid Signal enables businesses to carry out real-time risk assessments before initiating an ACH transfer to help avoid returns. 

What’s the difference between ACH and direct deposit?

A “direct deposit” is a type of payment made via the ACH network. It’s an informal name for common ACH credit transactions where individuals receive payments directly into their bank accounts.

The ACH-based payouts popularly referred to as direct deposits include:

• Salary and wages

• Social Security and pension benefits

• Tax refunds

However, not all ACH transfers are referred to as direct deposits. The term is generally not used when referring to transactions like peer-to-peer transfers and online bill payments made through banking portals, even though these payment types use the same underlying ACH protocol.

What’s the future for ACH deposits?

While ACH deposits already dominate the financial field for payroll and government cash transfers, there’s still a significant opportunity for them to replace the remnants of the paper check industry and better compete with wire transfers.

The first will likely happen as check-supporting infrastructure naturally winds down and legacy institutions move to digital payments. The second will require banks and fintech companies to continue to make using ACH easier, less burdensome, and less likely to experience transaction failure. This is already happening with the growth of same-day ACH payments. 

There are some challengers to ACH. New payment rails like RTP and FedNow, a government-backed instant payment rail, may disrupt the growth of ACH as businesses and consumers alike flock to faster payments. However, ACH payments are likely to be around for many years due to their lower cost, widespread infrastructure, and security.