James Newcome
- Senior Associate
- Pensions & Employee Benefits
Part 1 – Defined benefit (DB) surplus – UK government plans major changes to trapped surplus regime
On 28 January 2025, the UK Government announced proposed legislative changes aimed at unlocking scheme surpluses. The changes are aimed at allowing employers to access surplus funds ‘trapped’ within schemes to enable trustees and sponsoring employers the ability to boost wages, drive growth and ultimately provide funds to improve pension scheme members’ benefits.
Government proposals
Since the rise in gilt yields in 2022, Trustees and sponsoring employers of DB schemes have often found their scheme in a position of surplus, where assets exceed liabilities. Existing legal restrictions have often made surplus extraction difficult – either for employers to access the funds for investment growth to offset financial pressures, or in order to utilise the surplus funds towards augmenting members’ benefits.
The Government’s announcement summarises the key elements of the proposed changes, which include:
- Relaxation of rules permitting surplus extraction: The Government intends to introduce legislation that will allow DB schemes to modify their rules to facilitate surplus extraction.
- Trustee – Employer agreement: Any surplus extraction will require agreement between the scheme trustees and the sponsoring employer. This ensures that the interests of both parties are considered and that appropriate safeguards are in place.
- Protecting members’ benefits: The Government has emphasised that any changes will be subject to robust safeguards to protect member benefits. This includes ensuring member benefits are secure and that surplus extraction does not in any way jeopardise the funding position of the scheme.
- Emphasis on long term investment: The Government has indicated its wish to see some of the extracted surplus invested in UK productive assets.
Key Points: New legislation will allow DB schemes to modify scheme rules, enabling employers to access trapped surplus funds.
Any surplus extraction must be agreed upon by trustees and employers, with protections in place to secure member benefits and encourage long-term investment in UK productive assets.
Potential implications
Whilst much of the detail around the proposed changes (including legislation and regulatory guidance) is unknown, what is clear is that the changes will have far reaching implications for all stakeholders:
- Sponsoring Employers: The ability to access surplus funds could provide a much needed financial boost for employers. In theory, employers could use surplus to invest in the growth and innovation of their business, as well as in reducing debt. This is subject to considering the wider relationship with scheme trustees and the requirements around safeguarding member benefits.
- Trustees: Fundamentally, trustees must consider their fiduciary duties to scheme members when considering how to deal with a potential surplus. In effect, this means trustees should work collaboratively with sponsoring employers to ensure surplus extraction is conducted in a responsible and transparent manner.
- Scheme members: On the face of it, the proposed changes are intended to benefit employers. Trustees will need to ensure that robust safeguards are in place to protect members’ pensions, and any potential risks to these benefits must be considered. The Government may choose to impose appropriate protections in terms of ensuring the scheme is fully funded on a long-term basis or by reference to buy-out costs. Whilst the Pensions and Lifetime Savings Association has stated it backs the principle of surplus release, it notes that the “right protections” must be in place to “ensure member benefits are secure”. Clearly, further detail is needed around what protections there will be and how these will operate in tandem with any easements the Government introduces under legislation to enable trustees and employers to extract scheme surplus.
- The UK Economy: The Government’s proposals are based on the premise that approximately 75% of schemes are currently in surplus, with an aggregate figure quoted of £160bn. There is some dispute over whether much of this figure would be refunded to scheme sponsors due to the appropriate safeguards required to protect member benefits. Each scheme will also need to be treated on its own merits and not all schemes will take advantage of any easements that are provided when legislation hits the statute book.
Key Points: Employers could use surplus funds to invest in business growth, innovation, or debt reduction, but must align with trustees and ensure member benefits are safeguarded.
Trustees must act in members’ best interests, ensuring responsible and transparent surplus extraction while maintaining scheme sustainability. In other words, it is understood that government does not intend to water down scheme trustees’ fundamental fiduciary duties.
Further uncertainties
Whilst further detail will no doubt be announced in forthcoming government statements and in the legislation underpinning the changes, there are a number of areas that have not yet been addressed.
From a governance perspective, robust frameworks will need to be put in place to ensure all stakeholders understand the implications of the changes. Surplus extraction may provide a short term benefit in terms of improving the employer’s profitability, but trustees and employers also need to consider how the proposals may impact the long-term sustainability of the scheme. The investment risk profile of the scheme will also need to be assessed.
In a world where the majority of DB schemes are closed to new members and future benefit accrual, this could mean that any surplus will only benefit the members of that particular scheme.
However, if the surplus were paid to the sponsoring employer of the DB scheme, that employer could use the surplus to improve member benefits in the DC scheme. This could help ensure fairness across the workforce, but may be complex in terms of extracting the surplus from the DB scheme, before the wider workforce can see any significant change to their benefits under the DC scheme.
In their recent paper policy paper “Unlocking DB Pension Scheme Surplus”, the Association of Consulting Actuaries (ACA) have referred to employers who have already utilised surplus assets to provide better pensions for active employees in the employer’s DC scheme.
The ACA states it would “welcome the legal flexibility to use surplus DB pension assets to support pension contributions and obligations of the employer in a different trust, without incurring and reclaiming corporate tax relief” and “avoiding the need to set up DC (and in future, Collective DC) sections in DB trusts would also be consistent with Government policy for the consolidation of DC schemes and long-term asset pools”. It will be interesting to see whether the Government introduces additional easements in the new surplus regime to ensure the benefit of such surplus can be shared with the wider workforce via enhancements to the employer’s DC scheme.
Key Points: Robust governance frameworks will be needed to manage risks, ensuring surplus extraction does not threaten scheme sustainability.
If surplus is used for employer DC scheme contributions, legal and tax complexities must be addressed to ensure fairness across the workforce.
Wedlake Bell Comment
Against a backdrop of improved funding levels, the Government’s proposals for surplus extraction provide a marked shift from the current regime. Whilst the potential benefits for employers and the wider economy are clear, it is essential that the changes are implemented in a way that prioritises the security of member benefits.
Trustees, employers, and scheme members must engage in open and constructive dialogue to ensure that any surplus extraction is conducted in a responsible and transparent manner.
The Wedlake Bell pensions team will continue to monitor the developments surrounding these proposed changes and provide a further update once the details of the key legislation are known. It remains to be seen whether the changes will be in the Pensions Bill due to be introduced in Parliament before the summer recess starting on 22 July 2025 or will be in eg Regulations.
Meet the team: