Holiday pay should be simple, shouldn’t it? An employee takes a week off, you pay them for the week, and everyone carries on as normal. But what happens when that employee regularly works overtime?
This is where things can get complicated, especially for smaller businesses where overtime can vary month to month. The important principle is that employees should not necessarily see their income drop simply because they take holiday. So, if you have employees regularly working additional hours, it is worth checking how their holiday pay is being calculated.
First, Not All Overtime Is the Same
When looking at overtime and holiday pay, it helps to understand the three broad types of overtime.
- Voluntary overtime is exactly what it sounds like. You don’t have to offer it and, if you do, your employee does not have to accept it.
- Compulsory overtime is overtime that the employee is required to work under their employment arrangements.
- Non-guaranteed overtime sits somewhere in between. You don’t have to offer the additional hours, but if you do, the employee must work them.
Overtime payments may need to be included when calculating someone’s holiday pay, and court decisions have developed the rules considerably over the years.
What’s the Basic Principle?
A useful starting point is to think about what your employee would normally earn if they were at work.
Current government guidance says that the “normal” rate of holiday pay includes commission, regular overtime payments and certain payments linked to length of service or professional qualifications.
ACAS puts it simply: if an employee regularly received overtime pay in the previous year, most employees must have relevant overtime payments reflected in at least four weeks of holiday pay.
So, paying someone their basic salary and completely ignoring regular overtime could produce the wrong result.
What About Compulsory and Non-Guaranteed Overtime?
If overtime is part of someone’s normal working pattern and remuneration, employers need to take it seriously when calculating holiday pay.
The principle behind this makes sense.
Imagine an employee earns £500 in basic pay each week but regularly works overtime, raising their weekly earnings considerably.
If their pay suddenly drops back to £500 each week when they take holiday, statutory leave could leave them financially worse off.
That’s exactly the sort of situation the rules around “normal remuneration” are intended to address.
And What About Voluntary Overtime?
This is perhaps where SME employers are more likely to get caught out.
You might reasonably think:
“They don’t have to work the overtime, so surely I don’t have to include it in their holiday pay?”
Unfortunately, it’s not always that simple. The important question is how regular that overtime has become.
If an employee occasionally stays an extra hour during an unusually busy week, that’s very different from someone who voluntarily works additional hours week after week.
ACAS says holiday pay must include overtime payments if an employee regularly received overtime pay in the previous year.
So don’t simply look at what the employment contract calls the overtime. Look at what actually happens in practice.
Has the employee worked extra hours consistently? Has the additional pay effectively become part of what they normally earn? If so, it may need to be reflected in their holiday pay.
But Aren’t Employees Entitled to 5.6 Weeks’ Holiday?
Yes. Almost all workers are legally entitled to 5.6 weeks’ paid statutory holiday each year. However, the holiday pay rules can differ within that entitlement.
For regular-hours workers, current government guidance says that at least four weeks of statutory holiday must be paid at the worker’s “normal” rate of pay, while the remaining 1.6 weeks can be paid at a “basic” rate. Employers can, of course, use the normal rate for all 5.6 weeks if they prefer a simpler approach.
For irregular-hours and part-year workers, pay all statutory leave at the normal rate. This distinction matters when reviewing your payroll procedures.
How Do You Work Out the Average?
For someone with fixed hours but variable pay, calculating holiday pay generally involves looking at average pay over the previous 52 weeks. Separate rules apply to irregular-hours and part-year workers, but their holiday pay is also based on average pay over the previous 52 weeks. If there are weeks when the worker wasn’t paid, you may need to look back up to 104 weeks to find 52 weeks of relevant pay.
This is where strong payroll records become critical. You need to know what overtime was worked, what was paid and whether it represents a regular part of the employee’s earnings.
Why SMEs Should Review This Now
A large organisation with a dedicated payroll department may handle these calculations automatically.
For a smaller business, things can be less formal.
Perhaps overtime started occasionally but has gradually become part of somebody’s normal working week. Maybe you put your payroll process in place years ago and haven’t revisited it since. Or perhaps you’ve always calculated holiday using basic salary because that was simply how it was done.
A Few Questions Worth Asking
Have a quick look at your workforce and ask:
- Who regularly works overtime?
- Is it compulsory, non-guaranteed or voluntary?
- Has “occasional” overtime actually become quite regular?
- Does your holiday pay reflect normal earnings where required?
- Are your payroll records detailed enough to support the calculations?
- When did you last review your employment contracts and payroll procedures?
If you’re unsure about any of those answers, it’s probably worth taking another look.
Final Thoughts
Overtime and holiday pay is a good example of why payroll isn’t always as simple as pressing a button once a month.
The label attached to overtime is only part of the story. What matters, too, is what happens in practice and whether those overtime payments have become a regular part of someone’s normal remuneration.
And if all of this has left you thinking, “I’m not actually sure how we’re calculating ours,” don’t worry. That’s exactly what we can help with.
If you need help with payroll or want someone to sense-check how you’re handling overtime and holiday pay, please speak to your normal manager first.
If you are not yet working with us, let’s talk about where you are now, where you want to get to, and how we might help you get there. Here’s who we are.