The funding position of many defined benefit pension schemes has improved, shifting attention from deficit repair to surplus management.
For sponsoring employers and trustees, the key question is now what to do with excess assets. Options include retaining the surplus, using it within the scheme or, where permitted, returning part of it to the employer.
The right approach depends on the scheme’s funding level, governing rules, employer covenant and long-term objective. Some schemes may still target an insurance buyout. Others may prefer to remain open or continue running with a lower-risk investment strategy.
Under the current rules, extracting surplus from an ongoing scheme is difficult. The scheme usually needs to be fully funded on a buyout basis, its rules must allow a payment to the employer, and trustees must consider the release to be in members’ best interests.
These conditions mean surplus is often dealt with only at buyout or during wind-up.
Where a direct payment is not possible, the surplus can still have value. It may be used to pay scheme expenses, support future benefit accrual, fund discretionary increases, cover some early-retirement costs or contribute to a defined contribution section. These uses can reduce future cash demands on the sponsoring employer while maintaining member security.
Employers may also want to avoid creating a surplus that becomes difficult to recover. Contribution structures, escrow arrangements, scheme expenses and changes to investment risk can help control how quickly excess funding builds.
Proposed reforms expected from April 2027 could make surplus release easier.
The current buyout funding test is expected to be replaced by a lower threshold based on a low-dependency funding measure. Trustees may also be given power to amend scheme rules so that surplus can be paid to the employer, even where the existing rules do not allow it.
The requirement for trustees to show that a payment is in members’ best interests is also expected to be removed. Trustees would still need to protect accrued benefits and act prudently.
The reforms are likely to give schemes more flexibility, but they will not make payments automatic. Trustees are expected to require actuarial evidence, consultation with the employer, advance notice to members and formal confirmation of the scheme’s funding position. The regulator may also need to be notified.
Schemes are likely to retain a funding buffer above the minimum threshold. This would protect against changes in markets, longevity assumptions, asset values, unidentified liabilities or insurance pricing.
The strength of the sponsoring employer will also remain important. Trustees may require covenant monitoring, repayment protections, contingent security or limits on the size and timing of payments.
These controls are intended to reduce the risk of a scheme returning to deficit after surplus has been released.
Trustees and employers can prepare now by reviewing scheme rules, agreeing long-term objectives and testing funding assumptions. They should also decide how much surplus should be retained, how any payment would be calculated and what safeguards would apply.
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