How to Fund the Next Living Wage & National Minimum Wage Increase: Managing Pay Compression, Budget Pressures and Workforce Impact

Insight Article by

Joe Regan - Founder and Reward Strategy Partner
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What this article covers

What happens when the Living Wage and National Minimum Wage increase.
How pay compression affects organisations.
How to protect pay differentials.
Whether leadership pay reviews should reduce to fund front-line roles.
Whether headcount reduction or redundancy is a realistic option.
Practical funding strategies for HR, Reward and Finance teams.

What Is the Challenge with the Next UK Living Wage and National Minimum Wage Increase?

Each time the UK National Minimum Wage (NMW) and the Real Living Wage increase, employers must raise pay for their lowest-paid employees. These increases often outpace pay growth for higher levels, creating pay compression, affordability concerns and potential employee relations risks.

This article explains how organisations can prepare, protect pay fairness and manage affordability.

Pay Compression: What It Is and Why It Matters

Pay compression happens when the pay gap between entry-level roles and more experienced or skilled roles becomes too small.

Why Living Wage and NMW increases cause compression

Entry pay rises quickly due to statutory requirements.
Mid-level roles do not rise at the same pace.
Supervisors and experienced staff become “too close” to new starters in pay.

Benchmarking ensures that incentive levels remain competitive, equitable and affordable — avoiding unintended consequences like over-competition or disengagement.

Risks of compression

Loss of motivation for experienced staff.
Progression routes become less meaningful.
Retention challenges in supervisory and skilled roles.
Pressure to uplift multiple pay bands, not just the lowest.

Maintaining clear and fair differentials becomes essential to preserving career progression and operational stability.

Should You Reduce Leadership Pay Review Percentages to Fund Lower Grades?

Some organisations consider reallocating the pay review budget so more funds support lower-paid employees.

Advantages

Helps fund mandatory increases without exceeding total budget.
Demonstrates organisational values around fairness.
Protects the employees most affected by cost-of-living pressures.

Risks

Leadership or specialist salaries may fall behind market benchmarks.
Potential retention challenges for critical talent.
Reduced motivation and progression opportunity at senior levels.

A principles-based approach works best: protect compressed roles first, maintain affordability, and ensure transparency.

Should You Consider Headcount Reduction or Redundancies?

When wage increases create significant cost pressure, some organisations consider restructuring or redundancy programmes.

Before considering redundancy, assess:

Whether the increased cost can be absorbed over 12–24 months.
Whether allowances, overtime or premium payments can be restructured.
Whether role redesign or productivity improvements offer better value.
Whether alternative operating models could offset costs.

Risks of redundancy as a funding strategy:

Loss of key capability.
Redundancy costs outweighing savings.
Damage to employee trust and organisational culture.

Redundancy should be a last resort, backed by clear workforce planning and modelling.

Strategic Approaches to Funding Living Wage and NMW Increases

Restructuring pay bands and differentials

Adjust minimums and midpoints.
Reinforce progression steps.
Use job levelling to ensure internal consistency.

Reallocating the pay review budget

Prioritise compressed or lower-paid groups.
Reduce awards for over-market or senior roles.
Apply a tiered pay-review percentage model.

Reviewing total reward spend

Assess underutilised benefits.
Review allowances and shift premiums.
Target reward investment where it delivers the most value.

Workforce efficiency and role redesign

Improve scheduling, shift patterns and workflows.
Automate low-value tasks.
Consolidate responsibilities to create higher-value roles.

Scenario modelling for future increases

Forecast increases over the next three to five years.
Model best-, middle- and worst-case cost impacts.
Build pay forecasts into long-term budget cycles.

Communication: Protecting Fairness and Trust

Employees value clarity. How organisations explain pay decisions matters.

What employees want to understand

Why changes were made.
How fairness was protected.
How progression routes remain meaningful.
What principles will guide future decisions.

Transparent communication helps maintain trust during periods of pay pressure.

Conclusion: A Strategic, Not Tactical, Approach Is Needed

Living Wage and National Minimum Wage increases are an annual norm. Organisations need a sustainable, long-term reward strategy that supports fairness, affordability and operational performance.

Indigo Reward supports employers by:

Analysing pay compression.
Modelling Living Wage and NMW cost impacts.
Designing fair, competitive pay structures.
Reviewing total reward spend.
Supporting pay governance and people strategy alignment.

A proactive approach today prevents costly challenges tomorrow.

Explore Indigo Reward for Consultancy Support

FAQs

What is pay compression?

Pay compression occurs when lower-level pay increases close the gap with more experienced or skilled roles, weakening differentials and progression pathways.

How do companies fund the Living Wage increase?

Common strategies include reallocating pay review budgets, adjusting pay structures, reviewing benefits and allowances, improving workforce efficiency and modelling phased changes.

Should leadership pay be reduced to fund lower-level increases?

It can be considered but must be balanced against market competitiveness, retention risk and organisational values.

Do Living Wage increases lead to redundancies?

Not necessarily. Most organisations explore alternatives first. Redundancy should only follow a structured business case supported by workforce modelling.