While professionals usually aim to see their pay increase with time, some situations result in a reduction in their compensation. Pay cuts can be disappointing events or represent beneficial developments in your career. However, if you want to understand all the changes that could affect how much you earn, you might benefit from understanding the concept of pay cuts in greater detail. In this article, we define pay cuts, use examples to illustrate the five common types and provide some tips for handling a reduction in your pay.
What is a pay cut?
A pay cut is an official action taken by your employer that results in your overall compensation decreasing. While many professionals work in roles that receive varying levels of pay, such as a server earning tips, a decrease in pay only becomes a pay cut if it results from an intentional decision, rather than because of how you're compensated.
Though people often use the term "pay" to refer to income received for work, in the context of pay cuts, other forms of compensation count as pay too. Benefits such as pensions, for instance, represent a key aspect of employees' compensation packages. Therefore, if an employee loses such a benefit, it's important that they assess the effects on their overall financial well-being. Sometimes, an employer enacts a pay cut that affects an individual employee. Other times, employers enact pay cuts that affect a team, department, category of employee or the entire organization.
5 pay cut types
Here's a list of the five types of pay cuts you might experience as an employee or consider as an employer, each illustrated with an example:
1. Salary or wage cuts
A salary or wage cut is the most straightforward pay cut, where your employer reduces the total annual salary or hourly wage you originally agreed to when hired or after your most recent raise. In this scenario, your work schedule and responsibilities may remain the same, but you receive less compensation for fulfilling your duties. An employer may have to enact a salary or wage cut to remain operational, or a company might decide it needs to correct how it pays a certain position.
Example: A struggling technology company concludes it needs to cut employees' pay to stay in business. To maintain a sense of fairness, it cuts pay proportionally for every category of employee, with executives receiving a 15% pay cut, other salaried employees receiving a 10% pay cut and hourly staff receiving a 5% pay cut. A software engineer's salary goes from $100,000 to $90,000, and a janitorial employee's wage goes from $15 an hour to $14.25 an hour.
2. Benefits cuts
Benefits cuts occur when an employer reduces or eliminates a benefit that holds monetary value to employees. Benefits are a significant cost to employers who offer them, making them a primary option for companies trying to reduce their expenses. Losing some benefits, like a gym membership, may represent a financial inconvenience, but losing others, such as a certain healthcare plan, could have a tremendous effect on your personal finances. Some potential benefits an employer might cut include paid time off and sick days, commuter benefits, dry cleaning reimbursement and retirement benefits.
Example: A restaurant managed by a hospitality company decides it needs to reduce some of its employee benefits. Rather than change healthcare providers, the company eliminates both commuter benefits and dry cleaning reimbursement, which covered the cost of uniform cleaning. From the employees' perspectives, they lose an average of $85 in commuter savings and $24 in dry cleaning coverage per month, which represents a pay cut of $1,308 per year.
Related: FAQ: Employee Insurance Benefits
3. Bonus or raise cuts
Bonus or raise cuts are pay cuts that only affect additional compensation that employers either award routinely or as gestures of appreciation for excellent job performance. Some companies, for instance, give a fixed percentage bonus or raise that employees expect annually. Others may reward employees individually, depending on their evaluation of the team member's contributions. Because both bonuses and raises are often discretionary, they can be easier for employers to reduce than salaries or wages. Employees also might be less upset about a smaller bonus during a period of financial hardship than a salary reduction.
Example: Over the past year, a property management company has lost several of its core tenants in its commercial spaces. Hoping to protect the bottom line, management reduces its holiday bonuses from 7% to 4% of an employee's annual salary. The company avoids layoffs and minimizes employee discontent by acknowledging the need to reduce payroll expenses while leaving salaries unaffected.
4. Hours reductions
Hours reductions are pay cuts where an employer removes or shortens shifts from an employee's schedule. Reducing hours enables companies to spend less on labor without lowering the wages their employees agreed to previously. A key concern for full-time employees who lose hours is making sure they still meet the eligibility threshold for benefits.
Example: A clothing retail store worries that it might have to close if it doesn't save money on labor. Since most of its employees are high school and college-age students making minimum wage, the store owner decides to staff one less person per shift. Each employee loses one day of work and the corresponding amount of pay.
5. Voluntary cuts
Voluntary cuts occur when a professional willingly accepts less pay. Someone might change employers and sacrifice some compensation for overall satisfaction, or someone might want to change departments in their company and accept a position that pays less. In other cases, when faced with financial difficulty, an executive might take a voluntary pay cut to spare employees from pay cuts and help their company remain in business.
Example: An accountant wants to transition from working for a corporation to managing their own practice. Although the accountant currently makes a great salary, they feel they'd be much more satisfied working independently, networking with their own clients and developing sustained relationships. The accountant starts their own business and for a few years makes half of what they did previously. With time, the accountant gains enough clients to approximate their initial salary, but they're much happier overall and don't regret giving up the compensation they would've received.
Tips for handling a pay cut
If you choose to take a pay cut or your employer reduces your compensation, these tips might be useful for you:
Determine the consequences
When you learn of a pay cut, begin by determining its consequences for your personal finances. For some, a reduction in pay requires immediate action, so it's critical that you analyze your budget and confirm you're comfortable with your new level of compensation. Doing so might suggest your best next step, whether that simply means adjusting your discretionary spending or searching for professional opportunities elsewhere.
Related: How To Handle a Salary Cut
Assess the circumstances
Employers often do their best to remain optimistic and keep employees motivated. However, a pay cut usually suggests the organization is struggling or has identified a performance-related issue among staff. While not always the case, you benefit from assessing the reasons for the pay cut to the best of your ability. If appropriate, you can meet with your manager to learn more about the circumstances that resulted in compensation reductions.
You may conclude that the company faces a strong possibility of layoffs, further pay cuts or liquidation. If so, you benefit from deciding how you would proceed if you had to find your next job soon. You might begin researching openings and preparing your resume, for instance. Alternatively, you might conclude that temporary economic trends resulted in a difficult business cycle and feel confident that a return to normal is likely.
Although in most situations a business is within its rights to enact a pay cut, you can still attempt to negotiate. While you might not be able to alter the amount of the pay reduction, you can secure something in exchange for your lost pay. For instance, if your company announced it was eliminating commuter benefits, you could ask your employer to make their work-from-home policy more flexible, so neither you nor the company has to bear the additional expense.