Government confirms plans to relax rules on return of DB surpluses to employers

The government says the changes will remove barriers to the repayment of surplus, while maintaining safeguards to protect members’ benefits. It is also considering changes which might allow one-off payments out of surplus to be made to members.

In the long awaited response to the consultation on Options for DB schemes, launched by the previous government in February 2024, the government also confirmed it does not intend to take forward proposals to introduce 100% PPF protection for members in return for schemes paying a higher levy. However, it is still considering the merits of establishing a so-called “government consolidator” for DB schemes.

Return of surplus – new flexibility

In order to provide more flexibility over the return of surplus to employers from DB schemes, the government has confirmed it is minded to facilitate surplus being repaid to an employer out of an ongoing scheme where the scheme is fully funded on a low dependency basis. This contrasts with the current rules which require a scheme to be fully funded on a buy-out basis.

To help facilitate this, the government also plans to:

• introduce a statutory power for trustees to modify their scheme rules to provide for surplus sharing with employers, where their scheme rules do not currently allow this
• amend section 37 of the Pensions Act 1995 (which sets out the conditions that must be met for surplus to be paid to an employer from an ongoing scheme) to clarify that trustees must act in accordance with their overarching duties to scheme beneficiaries, which will remain unchanged - as part of this, it appears the government plans to modify the current statutory requirement for any return of surplus to be “in the interests of members”, and
• repeal the requirement for trustees to have passed a resolution under section 251 of the Pensions Act 2004 before 6 April 2016 for them to be able to share surplus with an employer while their scheme is ongoing

Importantly, repayment of surplus will continue to be subject to trustee agreement and to actuarial confirmation of a scheme’s funding adequacy. The government does not intend to specify how extracted surplus is to be used. It is also considering the merits of introducing a statutory power allowing for direct payments out of surplus to members.

The rate of tax applicable to surplus payments to employers from DB schemes will remain at 25%, although the government is continuing to consider the wider tax regime for surplus extraction. This may include introducing a mechanism for allowing lump sum payments to members out of surplus to be treated as authorised payments for tax purposes.

The government will bring forward the required legislative changes as part of the Pension Schemes Bill (which is expected to be published shortly) and in associated regulations, on which it will consult. The government also plans to work with the Pensions Regulator to develop and publish guidance for trustees on the extraction of surplus. This will be published further down the line - after the legislative changes have been passed.

100% PPF underpin

The government has confirmed it does not intend to take forward the proposals to introduce the option of a 100% Pension Protection Fund (PPF) underpin in return for a scheme paying a higher levy. The primary reasons given for this are that:

• it would be unaffordable for most schemes
• it has the potential to create moral hazard, and 
• the government does not think this is necessary to facilitate the repayment of surplus from DB schemes

Government consolidator

The government recognises that the commercial market will offer solutions through buy-out and consolidation for most DB schemes. However, it considers that existing options may not be viable for every scheme. Therefore, it is continuing to explore the option of setting up a government consolidator, run by the PPF, that it says would complement the existing market.

This could include an arrangement which offers the opportunity to consolidate for the hundreds of DB schemes that remain significantly underfunded on a buy-out basis. The government notes that these underfunded schemes, particularly the most mature, continue to pose a risk to the PPF and it sees commercial solutions as being unlikely to be available to them. It considers that a government consolidator could provide a viable option for these schemes and says any such consolidator would be structured to require the sponsoring employers to continue to meet their obligations to fund their pension liabilities.

The government notes there may also be opportunity for a government consolidator to have a wider scope with eligibility potentially extended to small, well-funded schemes. However, it recognises there is more to do on the approach to eligibility and determining how a consolidator could complement the emerging market rather than compete. Therefore, it will not be legislating for a government consolidator in the upcoming Pension Schemes Bill. 

Comment

While return of surplus from an ongoing scheme has always been theoretically possible, in practice, it is often unsuccessful due to a scheme’s rules, procedural hurdles, and/or the statutory requirement that trustees consider returning surplus to be ‘in the interests of’ members. The proposed changes look to address some of these hurdles and are likely to make surplus returns more feasible.

However, the need for trustees to consent before a return is made means employers and trustees will need to work together to agree when this can or should be done. Trustees will of course need to balance their fiduciary duties and the desire to ensure members’ benefits are protected with the need to take account of the interests of their scheme employer which may have legitimate concerns about not wanting to overfund its scheme. Trustees will also need to ensure they follow a proper process before coming to a decision and have regard to the Pensions Regulator’s guidance on this. The legislative changes may also open up opportunities for employers and trustees to consider making direct payments to members as part of a surplus sharing arrangement.

As far as employers are concerned, these reforms may make it more attractive for some of those with well funded DB schemes to run their scheme on for longer rather than moving to buy-out at the earliest opportunity. Assuming trustee consent can be obtained and the right protections put in place, it also opens up the opportunity for employers to explore different options for using any surplus in their scheme such as investing in their business or funding or enhancing the employer’s DC offering for current employees.