Best red circle rate policy for small businesses: what to do when someone is paid above the range maximum

For most US companies under 200 employees, the best red circle rate policy is to hold base pay, pay any merit increase as a one-time lump sum, and review each case at the next structure refresh. First confirm the range is not simply out of date or the job wrongly graded, because either one is cheaper to fix than a red circle. Write down a reason for every person above the maximum that has nothing to do with sex, race or age.

A red circle rate is base pay above the maximum of the range for the employee's current job. It shows up the first time a company puts its salaries next to a real structure, and it shows up in a very particular way: a few of your longest-serving, most trusted people are sitting on top of the grade. Nobody wants to tell those people their pay is frozen. The choice of policy is really a choice about how long they stay outside the range and how much that costs you, and the options differ more than most HR guides admit.

Check that it is really a red circle first

Before choosing any policy, work out why the person is over the maximum. There are three different situations that look identical on a spreadsheet, and only one of them needs a red circle policy at all.

• The range is stale. If the maximum was set three years ago and nobody has repriced it, the market moved and the range did not. Several people in the same grade will be near or over the top. Fix the range, not the people.
• The job is graded too low. The person's work grew and their title did not. A regrade clears the red circle on the day it is approved and costs nothing extra in pay.
• It is a genuine red circle. A lateral move into a lower-graded job, a counteroffer that was approved without moving the range, or years of merit increases on top of a high starting rate. This is the case the rest of this article is about.

The fastest way to tell them apart is to look at the whole grade at once. Paste the team into a salary range penetration calculator and look at the pattern. One person at 118 percent in a grade where everyone else sits between 20 and 60 percent is a genuine red circle. Four people above 90 percent is a stale range.

Five red circle policies, compared on real numbers

The comparison below uses one employee earning $125,000 in a range whose maximum is $113,636, so they are exactly 10 percent over. It assumes the company moves its ranges up 3 percent a year and gives a 3 percent merit increase for solid performance. The cost column is the extra cash paid over three years compared with holding base pay flat.

Computed by Wagelist. Freeze duration is ln(1.10) divided by ln(1.03). The half-increase row adds 50 percent of the dollar increase in the range maximum to base each year. The pay cut saving is $11,364 a year for three years.

Two things jump out. First, the lump sum policy and the half-increase policy cost roughly the same over three years, around $10,000 to $11,000, but the lump sum clears the red circle in less than half the time because none of the money lands in base pay. Second, the half-increase policy looks gentle and is the slowest real option on the table. At a 10 percent overage it keeps the person outside the range for seven years, and at 20 percent over it takes twelve.

The lump sum is the right default for a company under 200 people for a simpler reason as well: it keeps the pay-for-performance message intact. A strong performer who is told their raise is zero hears that performance no longer matters. A strong performer who receives a $3,750 check and a clear explanation hears that the range is catching up to them. If you already run a merit matrix, add a row above 100 percent penetration that pays the cell's value as cash.

What the federal government does, and why it pays half

The largest published US red circle policy is federal pay retention, and it is worth knowing because it is where the half-increase idea comes from. Under 5 CFR 536.305(a)(1), when the maximum rate of an employee's range goes up while they are on a retained rate, the employee is entitled to 50 percent of the amount of the increase in that maximum. Under 536.305(b), once the retained rate is equal to or lower than the range maximum, the employee gets the maximum and pay retention stops.

Here is what that looks like in dollars. The GS-13 step 10 rate went from $117,034 in Salary Table 2025-GS to $118,204 in 2026, an increase of $1,170. A GS-13 employee on a retained rate of $125,000 would receive half of that, $585, for a new rate of $125,585. That is a 0.47 percent raise in a year when the schedule itself rose 1 percent.

The design makes sense for a workforce the size of the federal civil service under statutory pay rules, where every change to base pay has to trace back to a statute or regulation. A 40-person company has none of those constraints. Copying the federal rule gives you the slow half of the federal system without the reason it exists.

Write down the reason, every time

Red circling is lawful, and the Equal Pay Act regulations say so directly. 29 CFR 1620.26 describes a red circle rate as an unusual, higher than normal wage rate maintained for reasons unrelated to sex, and gives the example of a long-service employee moved to less demanding work because of ill health who keeps their previous salary. The same section also closes the obvious loophole: where pay differences were set on the basis of sex, the higher rates may not be red circled to comply with the law.

The practical risk runs the other way too. Red circles cluster among long-tenured staff, and long-tenured staff skew older. A freeze policy that lands mostly on employees over 40 can draw an age discrimination claim. Under 29 CFR 1625.7(c) a practice that adversely affects older workers is defensible if it is justified by a reasonable factor other than age, and the employer carries the burden of showing it. A written structure, a documented range, and a note on each red circle explaining how the person got there is that justification.

In practice that means a short record for each person: the job, the range, the salary, the date and cause of the overage, the policy being applied, and the date it will be reviewed. It takes ten minutes per employee and it is the first thing anyone will ask for.

How long to let a red circle stand

No federal law caps how long an employee can be red circled, so the limit is yours to set. The arithmetic above gives a sensible anchor. Under a freeze with 3 percent annual range movement, 5 percent over clears in about 1.7 years, 10 percent in about 3.2, and 15 percent in about 4.7. Anything projected to take more than about three years is telling you something the policy cannot fix.

A good rule for a small company is to review every red circle at each structure refresh, and to force a decision at three years: regrade the job, move the person into a role that fits their pay, or accept the rate permanently and record why. Leaving it open-ended is how a company ends up with a grade whose real maximum is whatever the highest-paid person earns, which is also how pay compression starts one grade up.

Telling the employee

Have the conversation before the merit letter goes out, not in it. Explain where the range comes from, where their pay sits against it, what they will receive this year instead of a base increase, and what would change the picture: a promotion, a regrade, or the range catching up. Give them the review date. People react far better to a known timeline than to a quiet freeze they discover on a pay stub.

If a structure refresh has produced more than a handful of these at once, the follow-up letters are real work. The conversation should always happen live, but an assistant that drafts each follow-up email from your meeting notes can turn a stack of individual confirmations into an hour instead of an afternoon. Keep the numbers in each one checked by a person.

Frequently asked questions

What is a red circle employee?

A red circle employee is someone whose base salary is above the maximum of the pay range for their current job. The pay is kept rather than cut, but it is flagged so that normal merit increases do not push it further outside the range. It usually follows a demotion, a stale range or a counteroffer.

Can you give a raise to a red circled employee?

Yes, but most employers pay it as a one-time lump sum rather than a base increase. The employee still gets rewarded for performance, the cash does not compound, and the salary stays where it is until the range moves past it. Giving a full base merit increase means the person never returns to the range.

How long can an employee be red circled?

There is no legal limit, so it is a policy choice. Someone 10 percent over the maximum clears in about 3.2 years if ranges rise 3 percent a year and base pay is frozen, and in 7 years under a half-increase rule. Set a review date so the red circle does not become permanent by default.

What is the difference between red circle and green circle rates?

A red circle rate is pay above the range maximum. A green circle rate is pay below the range minimum. Red circles are usually managed by holding base pay, while green circles should normally be fixed straight away by raising pay to at least the minimum, because they tend to become pay equity findings.

Is red circling legal?

Yes, when the higher rate is kept for reasons unrelated to sex or another protected characteristic. The Equal Pay Act regulation at 29 CFR 1620.26 recognizes bona fide red circle rates, but says rates that were set on the basis of sex cannot be red circled to comply with the law. Document the reason for each one.

Should you cut pay for a red circled employee?

Rarely. Cutting pay to the maximum clears the red circle immediately, but it tends to cost the employee, and any reduction can only apply going forward. It makes sense mainly when the person moved voluntarily into a lower-graded job and agreed to the new rate in writing.

Start with a range you trust

Every number in this article depends on the range maximum being right. A red circle measured against a maximum somebody guessed three years ago is not a finding, it is a coincidence. Price the range from market data first, then decide who is really outside it. The mechanics of setting the maximum sit in salary structure design, and the raise side of the same cycle is in the salary increase calculator.

Sources: 5 CFR 536.305 (pay retention adjustments) and 29 CFR 1620.26 and 1625.7 via the Electronic Code of Federal Regulations; Salary Table 2025-GS and 2026-GS, US Office of Personnel Management. Policy durations and costs computed by Wagelist from the assumptions stated above the table.