The last time there were significant surpluses in UK occupational pension schemes was in the 1990s. These are now back in vogue following the boost to the funding levels of many defined benefit schemes over the last 18 months – a nice problem to have one might conclude! However the law in this area is complex and destined to evolve over the next few years following the Government’s recent policy shift towards making it easier for sponsors to access trapped surpluses.
Chancellor’s Autumn Statement 2023
According to Mercer’s latest Pension Risk Survey, the aggregate funding surplus of FTSE 350 companies defined benefit schemes doubled over the first 9 months of 2023. The consultancy has stated that the aggregate surplus increased from £35bn at the start of the year to £67bn at the end of September.
Clearly this is an indication of an improvement in funding levels for many defined benefit pension – a development which has been welcomed by trustees and sponsors alike. However, it does pose an interesting dilemma for sponsors and trustees as to what they might consider doing with any surplus.
On 22 November, the Chancellor presented the Autumn Statement, featuring several prominent announcements on pensions including plans to consult this winter on whether changes to rules around when defined benefit pension scheme surpluses can be repaid could incentivise investment in UK growth. This will include new mechanisms to protect members, and to encourage well-funded schemes to invest in assets yielding higher returns. It will also consider the option for DB schemes to elect for a 100% Pension Protection Fund underpin for those who opt into the new regime.
The rationale here is that with trustees being satisfied that members’ benefits are fully protected, healthy, well-funded schemes can adopt an increased level of investment risk, generating larger surpluses which in turn could benefit both members and sponsoring employers. In addition, freeing up funds for employers and investing in growth would be of benefit to the wider UK economy.
This consultation has been described in some quarters as a huge leap forward in plans to capitalise on the ever growing UK pension surplus.
Authorised Surplus Payment Charge
The Government has also announced that it would be reducing the authorised surplus payments charge from 35% to 25% from 6 April 2024. This reduction is good news for employers, who will suffer lower deductions on surplus payments. In essence it reverses out the tax relief arising when the employer made the contributions in the first place – tax exempt entities and charities will remain exempt from this tax charge. This category of employer did not receive tax relief on amounts contributed, and so no tax is due on the surplus funds coming out of the pension scheme.
Whether the reduction in this tax charge to 25% will see a rush towards sponsors accessing pension scheme surpluses remains to be seen. In our experience the present complex rules around the repayment of surpluses, trustee fiduciary duties (see below) on the use of surplus and limited capacity in the insurance market are the main obstacles to employers getting their hands on trapped surplus – not the tax charge.
Refund of pension surplus held to be reasonable
In October 2023, the Pensions Ombudsman issued his determination[1] in a case involving a complaint by a pensioner member of the Bristol Water section of the Water Companies Pension Scheme, a segregated pension scheme, with Bristol Water plc as its sponsoring employer. The trustee of the Scheme decided to return a surplus of approximately £12m to the sponsoring employer on the winding up of the Scheme.
Under the Scheme rules, the trustee was required to secure member benefits through the purchase of individual insurance policies and to comply with the relevant winding up legislation. With regard to surplus, the rules of the Scheme provided that the trustee may, in consultation with the employer, use any such surplus to augment the member’s benefits, “if it was just and equitable to do so” with any remaining assets being paid to the employers.
In this instance, after consulting with the employer and the members, the trustee decided that all of the surplus assets, less tax, should be returned to the employer on the completion of the wind-up of the Scheme.
The pensioner member in question contended that the Scheme funds should be used for the benefit of members only and thought that it was “morally indefensible …to boost [Bristol Water’s] profits and ultimately to pay it out as a dividend to shareholders”.
The Pensions Ombudsman did not uphold the member’s complaint.
The Ombudsman was satisfied that the trustee had followed the requirements of the Scheme rules and had interpreted them correctly. However, it was not within his remit to make a determination in relation to the trustee’s compliance with the underlying winding-up legislation – this was for the Pensions Regulator to determine.
In this particular case, the Ombudsman was satisfied that Bristol Water was a potential beneficiary of the Scheme on the basis that: (i) the Scheme rules explicitly provided that the sponsoring employer could receive a distribution of the surplus assets; (ii) where members’ benefits had been secured in full on wind-up, it was consistent with the purposes of the trust for the trustees to repay surplus where the rules allowed; and (iii) it was also appropriate for the trustee to take account of the employer’s interests when considering the distribution of the surplus as it has been generally accepted in law that trustees are able (and may in fact be under a duty) to take account of a sponsoring employer’s interests when exercising their powers under a pension scheme.
The Ombudsman was also satisfied after reviewing documentary evidence, that the trustee had considered all the potentially relevant factors which included:
- the views of the employer;
- the source of the surplus;
- member expectations;
- the fact that members’ benefits had been secured in full;
- that there had been past augmentations to members’ service; and
- the employer had made significant additional contributions to the Scheme to accelerate the de-risking strategy.
In light of his findings, the Ombudsman held that the trustee’s decision to return the surplus assets to Bristol Water was neither unreasonable nor perverse.
As more schemes find themselves in surplus, this determination provides a valuable lesson in documenting a thorough decision-making process supported by legal advice in order to protect against potential claims. In this instance the trustee had followed a prudent course of action.