The government has set out its plans to lift restrictions on how ongoing DB scheme surpluses are used. It has pledged to introduce a statutory override for trustees to modify their scheme rules to allow payment of surplus to sponsoring employers; lower the funding threshold for doing so; and amend the relevant legislation to clarify trustee requirements.

Trustees are likely to find sponsors keen to raise this, particularly as decisions made at the next valuation about long term journey plans and low dependency basis could have a real impact on the scope for surplus extraction in future.

On 29 May, the government set out its plans to lift restrictions on how ongoing defined benefit scheme surpluses are used. As expected, the Pension Schemes Bill published a few days later sets out the legislative framework to accomplish this, although all of the meaningful detail is to follow in regulations.

Both the government paper and the DWP’s press release state that there will be increased flexibility for DB pension schemes to “safely” release surplus worth £160 billion “to support employers’ investment plans and to benefit scheme members”, although there is already some suggestion that this number might prove wildly optimistic.

Statutory override

The government has pledged to introduce a statutory override for trustees of (most) ongoing schemes to modify their scheme rules to share surplus with the employer. (Schemes that are “being wound up” will be excluded, and regulations will allow other schemes to be excluded.)

Most schemes already have these powers but for those that do not, this opens a wide doorway to add them or alter any existing powers which present wording challenges when operating them.

“Threshold” to allow surplus to be shared

At the same time, it says it is “minded to” change the threshold at which this is allowed from the current insurance buy-out basis to the point where a scheme is fully funded on the new low dependency basis. The government says it considers this to be a “robust and prudent threshold at which to consider surplus extraction”. This would bring additional surplus into scope for potential extraction.

Trustee duties

The government has also said that it will amend the relevant legislation to “clarify” trustee duties in this area.

This may be the most important issue for trustees. Even if trustees have (or can have) a power to make a surplus refund, and the actuary can confirm that the legislative funding threshold is passed, the question as to whether that power should be exercised is always likely to be more challenging.

We have yet to see the detail of how members’ interests are to be protected by reducing a funding reserve for the future and if additional benefits have to be awarded as a part of the package. Trustees of an ongoing scheme will be looking at the interests of beneficiaries overall and there may be some difficult member inter-generational issues to grapple with between pensioners and deferreds. Some sponsors may find the provision of extra benefits to existing members unattractive where historic employer contributions have been material and the current workforce has fairly limited defined contribution provision.

Current legislation requires trustees to be satisfied that extracting surplus is “in the interests” of members. This wording leads some to conclude that surplus extraction can only be in the interests of members where benefit improvements are a part of the package. The security of benefits seems to be a lesser order issue, but for an ongoing scheme is arguably as important particularly for younger members.

The proposal is that the trustee duty require that trustees “must act in accordance with their overarching duties to scheme beneficiaries, which will remain unchanged”, with TPR guidance planned “to facilitate trustee comfort” in sharing surplus with employers.

It is unclear what this will mean in practice. Case law tends to suggest that the fiduciary duty of trustees is far more nuanced than a simple, overriding duty to act in beneficiaries’ interests, so the current statutory test may actually be more onerous.

The Bill itself does not attempt to define the fiduciary duty of trustees. In our view this is wise, and welcome. However, there may still be an intention to do this in regulations.

Use and taxation of surplus

There will be no restrictions about how employers can use any extracted surplus, although at present the tax charge on extracted surplus will remain at 25%. There are no current plans to relax the pension tax rules to enable one-off payments to members, but the government has said it will continue to consider the tax regime for surplus extraction.

What next?

As ever we must wait for the next level of detail to be revealed. That won’t be any time soon. According to the “roadmap” the DWP published alongside the Bill, consultation on surplus regulations is scheduled for Autumn 2026, with final regulations not until 2027.

In the meantime, trustees should expect surplus to be an issue sponsors are keen to raise, particularly in the context of agreeing the first valuation under the new scheme funding regime. Long term journey plans and low dependency basis could have a real impact on the scope for surplus extraction in future.

Key takeaway

Whether trustees can use their existing or the new powers on the use of surplus is one thing, but whether they will want to is quite another.