In a significant move announced on 28 January, Prime Minister Keir Starmer and Chancellor Rachel Reeves have confirmed that they will be taking steps to make it easier for DB schemes to make use of their surplus assets.  

The changes to rules around the utilisation of surplus assets in DB pension schemes come as part of a wider package of measures designed to kick-start economic growth and the figures are certainly eye-catching – the press release notes that approximately 75% of schemes are in surplus (calculated on a low dependency basis – see the Pension Regulator’s estimated DB universe funding splits published on 27 January 2025)to the collective tune of some £160bn.  It is easy to see why a Government in search of economic stimulus might seek to make it easier for schemes to use those excess assets, most of which are currently trapped in the schemes, productively.

It's an exciting move for an industry that has been patiently (or not so patiently!) awaiting an update on the new Government’s proposals for DB schemes. Unsurprisingly it has generated many column inches of commentary over the past few days.  If the changes come to fruition, the measures could mark the beginning of a shift in the way in which scheme sponsors view their DB schemes (for so long viewed as a liability but now potentially seen as a return-generating asset) and could have far-reaching implications for scheme sponsors, trustees, and members alike.

How did we get here?

Making better use of surplus DB assets has been a hot topic in the pensions industry for the past couple of years.  First tabled by the then Chancellor Jeremy Hunt in his Mansion House speech of July 2023, we have seen first a call for evidence and then a consultation about Options for DB schemes, including examining the current rules and barriers around building surpluses, and what changes could be made to make it easier for surplus assets to be extracted and used. 

As we noted in April 2024, we responded to that consultation.  In relation to surpluses, our response focused on the potential for the reform of the laws around releasing surpluses to make the running on of DB schemes a realistic and attractive option for sponsors and trustees alike, provided that sufficient safeguards for member benefits are in place. In September 2023 we also published a joint report with XPS Pensions Group and Premier Miton setting out how changes to the rules around how employers can use DB pension surpluses could generate £100bn in 10 years to be used to improve benefits for DB members, increase DC savings for employees or reinvest in the employers’ business.

There were indications that the then Government was minded to make changes to the surplus regime when it amended the rate of tax paid on surpluses returned from the scheme to sponsoring employers in April 2024, reducing it from 35% to 25%.  However, further progress was then curtailed by the General Election and Tuesday’s announcement is the first indication from the new Labour Government that it intends to pick up the baton from the previous administration when it comes to progressing reform of the laws around surplus release. 

What do we know? 

Under current regulations, the use of surplus assets in DB schemes is heavily restricted, and as a general rule surpluses tend to be considered “trapped” within the scheme until the point at which they wind up.  Accessing surpluses during the scheme’s lifetime while the scheme is “ongoing”, is much more difficult and what flexibility the trustees and employer have to do so is dependent on what their scheme rules say. That in turn depends on whether they passed the resolution they were required by law to pass by 2016 to preserve any existing powers under the scheme rules to return surplus on an ongoing basis – schemes that failed to do so may have lost the power.  In short – a “rules lottery”!

Yesterday’s announcement talks about surpluses in general and does not differentiate between surpluses on an ongoing basis and in wind up.  However, the measures seem to be focused on making it easier for surpluses to be accessed and utilised on an ongoing basis. The objective is clear – made in the context of other significant measures designed to stimulate growth and reinvigorate the economy, the announcement says that “restrictions will be lifted on how well-funded, occupational defined benefit pension funds that are performing well will be able to invest their surplus funds”, and that “pension trustees and the sponsoring employers could then use this money to increase the productivity of their businesses – to boost wages and drive growth or unlock more money for pension scheme members. High growth and more productive businesses boost the size of the economy which in turn will fund our vital public services.”

What don’t we know? 

The announcement so far is high level – the objective is clear and there are some indications as to the measures that might be deployed to get there but little in the way of concrete proposals.  We are told that details about the proposal will follow in the DB Options consultation response to be published “in the Spring”.  Detail in the announcement itself on the legal framework is limited to the following: 

• currently DB scheme surplus can only be accessed where schemes passed a resolution by 2016, so not all schemes can access surplus even if trustees and sponsors both want to do so. 
• legislative changes could enable all DB schemes to change their rules to permit surplus extraction where there is trustee-employer agreement. This allows trustees to assess the suite of options available in striking a deal with employers on how best scheme members can also benefit – linked to improving member outcomes. 
• Trustees have an overarching fiduciary duty to act in the best interests of their members. When considering surplus extraction, trustees must fund the scheme and invest its assets in a way that leads to members receiving their full benefits. We recently considered the case for clarification of the trustee fiduciary duties in our November 2024 article (explored further below). 
   

Accessing surplus is a two-stage process – firstly the trustees and sponsoring employer need to have the legal power to do so, and it sounds like the Government intends to put in place measures to facilitate adding / restoring such a power where that no longer exists or has never existed in the relevant pension scheme’s rules.  What form such a power will take will be interesting to see – could the original s251 power to pass a s68 resolution to preserve existing scheme powers be resurrected? Or might we see a more wholesale statutory override power to give trustees and employers the ability to agree to insert a surplus distribution power.

Where the relevant legal power exists, the parties also need to be comfortable that any proposed surplus distribution decision is reasonable, that member benefits are adequately protected, and, from the Trustees’ perspective, that their fiduciary duties are met.  The announcement does not set out any detail on how this second phase of the question might be addressed. 

Interestingly, it is not explicit in the announcement either that the surplus would necessarily need to be extracted from the scheme in order to be utilised – in fact much of the announcement discusses freeing up how the pension scheme’s surplus assets can be “invested” e.g. “restrictions will be lifted on how well-funded, occupational defined benefit pension funds that are performing well will be able to invest their surplus funds”. Could greater flexibility be introduced for schemes funded above a specified (and very prudent) level to invest in riskier asset classes or even perhaps an exemption from employer-related investment restrictions for assets over and above a specified level, to allow employers to invest in their own businesses for growth within the scheme wrapper?

Will there be any benefit for using the surplus in specific ways?  Even with the proposed changes to make it easier to access and use surpluses, the tax penalty for removing the surplus from the scheme and paying it to the employer still stands at a hefty 25% (albeit down from an even more penal 35% pre April 2024).  Might we see a lower rate of tax payable in return for investing in ways that the Government is keen to encourage e.g. investing in their business’s growth or infrastructure? 

Or a tax concession for those employers who use DB surplus to fund contributions (maybe in excess of auto-enrolment minimum levels) to DC schemes for current employees (who will typically have much less generous pension arrangements than the older workforce who were able to participate in the DB scheme (most of which are now closed in the private sector)).  At the moment, in certain circumstances, employers with DB and DC sections within the same scheme can benefit from using DB surplus to fund contributions to the DC section (and can do so within the scheme wrapper, thus protecting them from the tax charge).  Could we see a levelling of the playing field by extending this flexibility to all?

Other factors to consider

As many commentators, including the Pensions Regulator and the PLSA, have already highlighted, putting in place appropriate guardrails to protect members benefits will be key.  As well as a prescribed minimum funding level to be met before a surplus distribution can be considered, we would also expect to see measures around governance and decision making.  These might include:

• requiring trustees to obtain independent advice before making decisions on surplus utilisation, including in relation to employer covenant; 
• implementing robust risk management frameworks to assess the potential impact on the scheme’s funding position; 
• ensuring transparent communication with scheme members regarding the use of surplus assets;
• a clear regulatory framework to support trustee decision making in respect of surplus – in our joint paper with XPS and Premier Miton (referred to above), we suggested that any new power to distribute surplus could be accompanied by a new Code of Practice from the Pensions Regulator covering areas including: 
  • minimum funding level to be maintained following any surplus distribution;
  • how to take account of the interests of DB members;
  • best practice in operating, monitoring and distributing surplus

      The Code could also include case studies and examples to illustrate the role trustees are expected to play in surplus decision making, and approaches that work from the Regulator’s perspective; and / or 

• prescribing that the decision to distribute surplus in an ongoing scheme falls within the notifiable events regime, to give the Pensions Regulator oversight of payments that are being made.

Trustees will play a crucial role in the implementation of these proposals. They will need to navigate the complexities of the new regulatory environment, balancing the interests of members with the opportunities presented by greater flexibility. Enhanced governance and risk management practices will be essential to ensure that decisions are made prudently and transparently. 

In order to give trustees the ability to make surplus distribution decisions with confidence, some clarification of the scope and content of the fiduciary duty in this context would no doubt be very welcome.  More broadly, clarification of the concept of fiduciary duties is another of the pensions world’s ongoing discussions, and, as mentioned above, we recently published this article examining the key questions around trustee fiduciary duties in detail, and highlighting the case for potential reform.  It may be the case that the new measures around surplus release need to be accompanied by some form of clarification of how they would inter-act with a trustee’s fiduciary duties in order to give trustees the framework they need to be able to reach decisions regarding surplus release on an ongoing basis.

Conclusion

While much of the detail is still to be revealed, the Government will no doubt be encouraged by the generally warm reception from the industry to its “in principle” proposals.  The Pensions Regulator has expressed its support for the Government’s plans for DB surpluses, whilst of course prioritising the security of member benefits.  Chief Executive Nausicaa Delfas said: 

“Where schemes are fully funded and there are protections in place for members, we support efforts to help trustees and employers consider how to safely release surplus if it can improve member benefits or unlock investment in the wider economy.”

We await the DB Options consultation response (the Government has indicated it will be coming in the Spring) and details of the proposed changes for the laws relating to surpluses with interest.  Ahead of that consultation response, our Head of Pensions and Lifetime Savings Richard Knight is delighted to be joining key DB counterparts from XPS on Thursday 6 February to discuss some of the talking points highlighted in this article. If you would like to join the conversation, please follow this link to sign up:

XPS Live | How the Government's DB surplus plans might impact you