Benefits cuts may be a better solution than pay cuts

There has been much publicity surrounding the decision of many employers to ask their staff to work for a period without pay or to reduce pay. While cutting employees’ basic pay is headline news, what is often not reported is the impact that pay cuts can have on employees’ benefits.

There is a potential hidden cost to agreeing to salary reductions. Therefore, it may be better for staff and employers to consider reducing benefits rather than reducing pay.

Some benefits linked to an employee’s pay which may be affected by any drop in pay, include pension schemes. For defined benefit schemes, if the reduced pay is taken into account when calculating final pensionable pay, then this could mean reduced pension benefits for the employee, although the precise impact will be subject to the rules of the pension scheme.

For defined contribution schemes, where pension contributions made by the employer and employee are based on a percentage of the employee’s salary, a cut in pay may lead to a corresponding cut in the contributions, unless employers agree to maintain the level of contributions at the rate prior to the pay cut.

Then there’s statutory maternity pay (SMP).

As the first six weeks of SMP is based on the woman’s weekly earnings in the eight-week period before the 14th week preceding the expected week of childbirth, a cut in pay during that period will lead to reduced SMP for the first six weeks, which are paid at 90% of normal weekly earnings.

Other benefits could well also be affected by pay cuts or unpaid leave. These include those based on pay, for example, where death-in-service payments or critical illness cover uses a multiple of the employee’s salary.

The precise impact will vary depending upon the rules of the scheme referred to above, and the terms of any insurance policy provided to employees in respect of these benefits.

As mentioned, reducing employee benefits may be preferable to cutting pay. But how is this best done?

Where benefits are non-contractual, they may be reduced or withdrawn without the need to obtain the employee’s consent. Employers can therefore make immediate savings by withdrawing, for example, free meals and refreshments, prohibiting first-class travel, imposing limits on expense claims, or reducing non-guaranteed overtime.

Alternatively, there may be flexibility within existing contracts of employment entitling employers to make certain changes to benefits without being in breach of contract. In this case, the flexibility should still be exercised in a non-arbitrary and reasonable way so as to avoid any breach to the duty of trust and confidence.

Where the changes are to contractual benefits, employers cannot simply impose a reduction as this may constitute a fundamental breach of contract, entitling the employee to resign and claim constructive and (if they have more than a year’s service) unfair dismissal. The best option therefore is to try and obtain the employee’s consent to any variation to their benefits.

As a last resort, and if after a period of consultation, employees refuse to agree to the variation, the employer may choose to impose the changes. They should, however, consider the risks of doing so, and the manner in which they go about doing so.

As a starting point, employers will need to ensure that they have substantial business reasons for imposing the changes, have balanced that against the detriment to the employees, and acted reasonably by consulting employees and seeking their agreement. The business rationale for the changes will therefore be critical, and employers will need to consider the hidden impact of changes to pay on benefits in establishing this business case.

Key points

  • Discuss with employees the knock-on effects of pay cuts on benefits

  • Consider whether benefits cuts may be a better option for both parties.

  • If cutting contractual benefits, get employee agreement.

  • If not employers will need sound business reasons to do so.

Paula Bailey, partner, Howes Percival

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