The national living wage is to rise by 6.2% in what the government says is "the biggest cash increase ever".
The rise is more than four times the rate of inflation and takes hourly pay for people over 25 to £8.72 from April.
Prime Minister Boris Johnson said: "For too long, people haven't seen the pay rises they deserve."
But businesses warned that a sharp increase in wages would put pressure on companies and urged the government to reduce costs elsewhere for firms.
The national living wage is the government-mandated minimum wage for over 25-year-olds. The minimum wage for under-25s will also rise.
Hannah Essex, co-executive director of the British Chambers of Commerce, said that many companies "have struggled with increased costs in a time of great economic uncertainty".
"Raising wage floors so far above the rate of inflation will pile further pressure on cash flow and eat into training and investment budgets," she said.
"For this policy to be sustainable, government must offset these costs by reducing others."
From April 2020, the new rates are:
- The National Living Wage for ages 25 and above - up 6.2% to £8.72
- The National Minimum Wage for 21 to 24-year-olds - up 6.5% to £8.20
- For 18 to 20-year-olds - up 4.9% to £6.45
- For under-18s - up 4.6% to £4.55
- For apprentices - up 6.4% to £4.15
An independent report published this year said there has been little or no evidence of job losses as a result of rising minimum wage levels, which are currently set at £8.21 for people aged 25 and over and £7.70 for 21 to 24-year-olds.
Professor Arindrajit Dube, an academic in the US and an expert on the subject, said there was "room for exploring a more ambitious national living wage" in the UK in the coming years.
He stressed, however, that because there is relatively little evidence available, the independent Low Pay Commission should be able to review the effect on jobs as pay increased.
But the Federation of Small Businesses (FSB) said "an increase of this magnitude" means firms may recruit fewer people, cancel investment plans or consider redundancies.
"There's always a danger of being self-defeating in this space," said Craig Beaumont, FSB director of external affairs and advocacy.
"Wage increases aren't much good to workers if prices rise, jobs are lost and there's no impact on productivity because employers are forced to cut back on investing in tech, training and equipment."
He said that small firms will need support, especially as there will be a 1.7% increase in business rates in April next year.
The government also said it will press ahead with recommendations by the Low Pay Commission to allow workers over 21 to receive the national living wage by 2024 when it is set to reach £10.50 an hour.
Since the National Minimum Wage was introduced by a Labour government 20 years ago, it's boosted the wages of the lowest-paid - defying predictions it would lead to higher unemployment.
After 2016, a rebranded National Living Wage boosted incomes further for low-paid workers over 25. And in September the government accepted a recommendation from the Low Pay Commission that the new, higher minimum should gradually be phased in for younger workers over 21.
The policy has helped to cut the number of people officially defined as being on low pay - those who earn less than 60% of the average - reducing income inequality.
Those on the minimum wage now earn 13% more, in real terms, than they did in 2008.
But this hasn't prevented rises in the number of working households in poverty. And in 2019 the average worker's pay still bought less, after taking account of inflation, than it had 11 years previously.
Labour has called for a £10-an-hour minimum wage and said the government had not gone far enough to help those on the lowest pay.
"This announcement falls short on what is needed to help workers and comes against a backdrop of an economy created by Conservative governments over the past decade that has left millions of people trapped in low paid, insecure work and underpayment of the minimum wage on the rise," said shadow work and pensions secretary Margaret Greenwood.
Frances O'Grady, general secretary of the Trades Union Congress, said workers needed a national living wage of more than £10 "now, not in four years' time".
"This is a long-planned raise, but it's also long overdue. Workers are still not getting a fair share of the wealth they create. And in-work poverty is soaring as millions of families struggle to make ends meet," she said.
The Resolution Foundation, a think tank which focuses on the living standards of low and middle-income people, welcomed the plan but its economic analyst, Nye Cominetti, said it was "not risk-free" in terms of inflation.
He said: "It should be matched by a renewed commitment to swiftly evaluating evidence of the impact of such large and sustained minimum wage rises and acting on that evidence if problems emerge."
The Living Wage Foundation calculates a separate, non-binding wage level which it describes as a fair level of pay, reflecting the cost of living. Around 6,000 UK employers pay this voluntary "real living wage" of £9.30, or £10.75 for those in London.