5 Types of Pay Cuts, When They’re Legal and When They’re a Good Thing

Pay cut. It sounds like a nightmare and something to avoid at all costs. And in some cases, it can leave you in a lurch. 

But other times, it’s not necessarily the tragedy you think it will be. In fact, it may even open up doors to new opportunities — and you could elect to take one voluntarily! 

Of course, that’s not always the case. What are pay cuts all about? And why would anyone choose to take one? Let’s take a look.

What is a pay cut?

A pay cut is a decrease in an employee’s compensation. It could be a reduction in salary, benefits, hours and more — it’s not limited to monetary compensation. It can happen for a variety of reasons. For example, a company might be trying to avoid layoffs and/or save money during a tumultuous period, with the intention of returning salaries to normal once the threat is over.

During the pandemic, for instance, some businesses attempted to hold onto as many employees as possible by implementing (hopefully temporary) pay cuts to help them weather the economic storm.

Are pay cuts legal? When can a company cut your pay?

The short answer is yes — in the vast majority of cases, pay cuts are perfectly legal. That’s because most employment contracts in the United States are at-will, meaning both the employer and employee can sever the relationship at any point for any reason, with some limitations, such as for discriminatory purposes. You can be laid off or fired, as per the terms of at-will employment. This also applies to changing the payment terms, including reducing salary, hours, benefits and so on.

How much can your pay be cut?

Your pay can be cut by any amount. However, if you’re an hourly (non-exempt) employee, your employer cannot reduce your pay such that it falls below the federal minimum wage of $7.25 per hour. If your state has a higher minimum wage, your employer must meet this threshold. For example, California’s minimum wage is $14.00/hour for employers with more than 25 employees and $13.00/hour for employers with 25 or fewer employees. 

Bear in mind that employers must abide by the minimum wage that is higher — state or federal. Hourly employees are also entitled to overtime pay if they work more than 40 hours per week, as per the Fair Labor Standards Act.

In order for an employee to qualify as exempt or salaried, they must earn at least $684 per week. Again, states have individual laws about these thresholds, too. If they earn below that threshold, they must qualify for overtime. They would also be subject to hourly employment minimums.

Legal protections against pay cuts

Even though pay cuts are usually legal, there are some measures in place to protect workers. For example:

• The employee must be notified about the pay cut in advance. The employee must agree to the pay cut; alternatively, they may choose to leave the employer. Moreover, the pay rate may not be reduced retroactively.

• As noted above, the employee must still earn at least minimum wage. (However, the employer may reduce an employee’s hours.)

• An employer cannot cut pay for discriminatory reasons because of an employee’s membership of a protected class, such race, gender, age or disability status. 

• Pay may not be reduced for retaliatory reasons, such in response to an employee filing a harassment complaint against the employer.

• Pay cuts must be made equitably across the company. (Again, not doing so would be discrimination.)

• Employees who are protected by certain contracts, such as union contracts, usually may not be subject to pay cuts if that would constitute a breach of contract.

• Employers must comply with all employment, local, state and federal laws.

The 5 types of pay cuts

There are several different types of pay cuts — not just salary. The most common types are:

1. Salary or hourly wage cuts

This is the type of pay cut people usually think of when it comes to pay cuts. Like it sounds, this means a reduction in your annual salary or hourly rate. In some cases, the pay cut can be quite substantial. However, as we’ve discussed, employers must still comply with federal and state minimum wage laws and continue to pay overtime if the employee is hourly and works more than 40 hours per week. Some employers will also cut the number of hours an employee works in order to comply with minimum wage laws. 

Some employers furlough employees, meaning they keep them on staff without pay for periods of time. This became common during the pandemic. A furlough is also known as a leave of absence, and the employee is not paid for the time they are furloughed. If the employee is expected to work during their furlough, they must be compensated at least minimum wage for that time.

2. Benefit cuts

Rather than or in addition to reducing salaries, some businesses might elect to downgrade or do away with certain benefits, such as health insurance, which can be expensive to maintain. While larger companies are required to provide health coverage to full-time employees or pay a tax penalty, the plan they choose to offer is up to them, so they may opt for a less expensive option. Smaller businesses with fewer than 50 full-time employees don’t have to comply with this law.

An employer can also choose to amend other benefits, such as vacation time or paid time off (PTO), wellness reimbursements, travel reimbursements and so on.

3. Bonus and raise cuts

There’s no law that says you have to get a raise every year — or a bonus. While state minimum wages sometimes change and employers must comply with those laws (the federal minimum wage hasn’t changed in over a decade), they don’t need to change employees’ salaries unless they are contractually obligated to do so. 

And, as you might guess, bonuses are often the first to go — since they’re bonuses, after all. This can be discouraging for people in professions in which bonuses are usually par for the course, like sales, but businesses often see this as a good way of cutting costs while curbing the number of layoffs or furloughs.

4. Reduced hours

In order to maintain employees’ hourly rate of pay, employers might instead reduce the number of hours each employee works. Of course, this will still mean the employee’s paycheck takes a hit since they’ll be earning less money overall. Some people might be able to make up for the loss in pay by working other jobs or side hustles. Others may experience a financial hit.

Be careful when evaluating a reduction in hours. If you’re currently receiving benefits, and the loss in hours will mean that you’ll become a part-time, rather than a full-time, worker, you could lose those benefits in addition to the monetary loss.

5. Voluntary pay cut 

In some cases, an employee may choose to take a pay cut voluntarily. There are several reasons why someone might choose to do this (we’ll go into greater detail below). Often, it means you have another opportunity to pursue, and a pay cut isn’t necessarily a bad thing.

When should you take a voluntary pay cut?

It may seem counterintuitive, but this can sometimes be a good thing! Here are some reasons and motivations to voluntarily take a pay cut.

• You’re changing careers or industries and are starting out in a lower-level position. (Hopefully, what you lack in salary you’ll make up for in job satisfaction! Plus, you’ll be able to make it up as you gain experience.)

• You have an opportunity at a different company where you think you’ll be happier, although the pay is lower. On the other hand, you might be able to climb the ranks more quickly — such as if you come from a huge corporation and move to a startup.

• You’re starting your own business — where you won’t earn money at first — or becoming a freelancer. 

• You’ll gain more benefits or flexibility or achieve a better work-life balance if you take a pay cut — this might be a way to avoid burnout. (Sometimes, you can negotiate better benefits by taking a pay cut.)

• You’re an executive or high-level employee who can afford to take a pay cut to help the business survive if it’s struggling.

• You are relocating to an area where the cost of living is less expensive, and the employer agrees to telecommute with a pay reduction commensurate with the cost of living in the new area. (This was more common pre-pandemic when remote work was more unusual.)

While pay cuts aren’t ideal, they’re not always the disaster you might fear they are. In fact, sometimes they can serve you well and open up doors to even better opportunities that will make you happier and more fulfilled in the long run, even enabling you to pursue your dream career. 

Still, there are, of course, circumstances when a pay cut will adversely impact you financially. You should rely on your common sense and instincts when you’re faced with a pay cut. If you fear the reduction will leave you scrambling to pay bills, consider which other options are available to you — including looking for a new job.