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Happy New Year! We would like to cut your pay by 10%.
Many employees will hear this kind of message this month. Employers will usually explain to staff that there is a choice between making people redundant or sharing the pain across the workforce and cutting pay.
Pay cuts of 10 or 20%, some for a limited period (typically six months) and some with no time limit, are becoming more commonplace. Workers at JCB in Staffordshire recently voted for a wage cut of around £50 a week in order to save jobs. Workers with other car manufacturers are also in talks for similar cuts or are being forced to work shorter weeks.
Employment lawyer Michael Burd of solicitors Lewis Silkin, who has prepared some pay-cut schemes for employer clients, says: "There's a sense of people being willing to rally round and sacrifice something for a greater good."
But employers and employees alike are in new territory here - and workers need to be careful about what they sign up to. By law, employers cannot unilaterally cut an employee's pay. If, in exceptional circumstances such as the current recession, employees agree, they need to be aware of the implications for any subsequent redundancy payment and their pension rights (see below). It can be worth negotiating collectively, either through your union or by getting your colleagues together. No one can force you to take a pay cut, so you could reject such an offer even if your fellow workers accept.
Many organisations will now be raising the idea of pay cuts - particularly those (the vast majority) that start their working year on 1 January or in April. Human resources chiefs have been looking at alternatives to redundancy. Lewis Silkin says more career breaks are being offered with, for instance, staff being offered 20% of pay while they take time off. "Employers have spent a lot in training staff and don't want to lose their investment," it says.
So what should you bear in mind if a pay cut is proposed?
How long is it for?
Put a time limit on how long you will accept reduced pay. "Maybe six months, a year at most," says Richard Lynch, negotiating officer for the trade union Unite. "Things are going to improve at some stage."
Discuss with management the impact on redundancy terms. Since redundancy packages are nearly always based on individual pay terms, you could end up getting a smaller payoff if your employer decides to sack staff or if it goes into administration while you are on reduced pay. If your pay cut is temporary, your redundancy package should not be reduced, says Teresa Dolan, employment specialist at the law firm Hammonds, but whether something is temporary is not always clear, so you should resolve the issue up front and get it in writing. "It's very important to the employee to get it recorded somewhere," says Dolan.
What impact will it have on the benefits I receive?
Employers will sometimes propose a cut in hours to match the pay cut. If they do not, employees should raise this. Employees who receive child tax credit and/or working tax credit can have problems if their weekly hours fall below 30 (for, generally speaking, childless couples and singles) or 16 (for parents and disabled workers). Not only can they lose income, but they can get into an administrative nightmare of reporting declining and rising hours; losing some or all of the extra money they get; receiving overpayments (which have to be recovered or repaid); and, if their hours go back up, making new claims.
"Tell the Revenue [HM Revenue & Customs] straight away when your hours go down and tell them when they go up again," says Beth Lakhani of the Child Poverty Action Group. This may sound obvious, but the CPAG is worried that people may find themselves losing money and being penalised in an unwieldy part of the benefits system if they do not follow the rule book closely.
You can also expect your death-in-service benefits to be reduced if your pay is cut unless you negotiate otherwise with your employer.
Should I reduce the sum covered by my income protection insurance?
The cost saving would be "negligible", says Garry Spencer of Wilbury Financial Management, and you could be required to start a new policy, for which "there's often a three-month moratorium during which they won't pay out". The fact that your pay is being cut could later be cited as a sign that your employer was in trouble - a reason the insurer could use for not paying you if you lose your job. Such issues should not apply if you don't change your policy.
What impact will it have on a mortgage?
If you apply for a mortgage or remortgage, "the likelihood is that lenders will work on the reduced level," says Richard Morea of London & Country Mortgages - unless, perhaps, you can show them a document from your employer agreeing to put your pay back up on a given date.
Can I look for other work to fill the gap in my income?
Be ready to ask your employer for consent if you want to start working part-time elsewhere. "It depends on what is in the contract," says Dolan. Employers often insist that workers get permission - under the working time regulations, they have a duty to monitor all the hours employees work for health and safety reasons. In most cases, permission should be given. For senior staff or people working in sensitive areas, might not be given. A law firm, for example, might not want a lawyer to work for a rival.
How about my pension?
No one should agree to a cut in pay without raising the implications on any employer-run pension scheme.
The signs are that, while some employers are discussing the implications of pay cuts with employment lawyers, few are exploring the effects on pensions with specialists. In fact, the potential problems could be ironed out easily. But, if they are not addressed, some workers could simply see their pension income cut forever because they agreed to a short-term pay cut.
The particular problem is in defined benefit pension schemes where employees get a pension based on their final salary - either at the time they leave the company or when they retire. If someone agrees to a six-month pay cut and is made redundant in that time, his or her final annual salary, and therefore pension, will probably be lower. But Matthew Giles, pensions lawyer at Hammonds solicitors, thinks a solution to this kind of problem could fairly easily be negotiated: "Employees could say: 'I'm only going to accept a temporary pay cut on the basis that it does not have an effect on my pension.' This would probably involve an amendment to the pension scheme."
Not all defined benefit schemes would be affected in the same way, as the formula for calculating the final salary varies. Some use the average of the last three years, for instance. It is important to look at exactly what the terms of the scheme are. (Unions tend to be much more experienced at negotiating pay than pensions, so employees might want to do some of the legwork on this themselves.)
For money purchase schemes - where employers and employees put in agreed percentages of pay into pensions - the issues are different. Employees could ask that the percentages stay linked to the previous pay level, rather than falling with the cut pay.
Finally, employees who are short of cash could cut their pension contributions for a while. But Tom McPhail of adviser Hargreaves Lansdown says: "This is the very worst moment to stop. People who stop may be slow to restart, and could miss out on the recovery in share prices when it comes.
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