The return of return of surplus?

On 10 July, the Government announced its ‘Mansion House Reforms’, consisting of a number of proposed updates and initiatives to boost pensions and other savings whilst supporting overall growth across the UK economy.

As part of the Mansion House Reforms, the Government has suggested that it might be prepared to relax the rules around pension scheme surpluses to make it easier for scheme sponsors to receive surplus funds from their defined benefit (DB) pension schemes.

Many DB pension schemes have seen significant improvements in their funding levels in the past year, principally as a result of the drastic shift in gilt yields following the LDI crisis of late 2022. According to analysis carried out by Barnett Waddingham on FTSE 350 companies, it is estimated that their DB schemes currently hold £50bn in assets exceeding 105% of funding levels.

There is currently little motivation for scheme sponsors to continue to grow surpluses in their DB schemes; there are very strict rules regarding what can be done with surplus, with the sponsor only able to release cash from the scheme in certain very limited circumstances. In addition, there is a 35% tax charge on any surplus returned to an employer. As a result sponsors and trustees of well-funded schemes are more likely to opt for a low risk investment strategy in order to safeguard the current surplus, rather than invest in growth assets.

The Department for Work and Pensions has now issued a consultation over whether the return of surplus rules should be relaxed, for example, by allowing cash to be returned to the sponsor after schemes have entered buy-in and all benefits have been secured with an insurer. There is a clear balance to be struck here between securing members’ benefits by locking in a scheme’s current positive funding position and encouraging further investment and growth of scheme assets, and thereby boosting the wider UK economy.

Employers will undoubtedly be excited at the opportunity to reclaim surplus funds in DB schemes that they have poured money into for years without seeing much progress. Trustees will likely be concerned about yet another changing of the goalposts on pension scheme funding and the danger that their members’ benefits are less secure in the future. But for schemes supported by a strong covenant there could be an opportunity for both parties to win.

Please get in touch with a member of our pensions team if you’d like to discuss the Government’s proposed reforms.

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