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Written by:

Morten Nilsson

Chief Executive Officer (CEO)

Read Time:

6 minutes

Published:

20 / 03 / 2024

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Surplus extraction – a hefty prize but what’s the price?

Up until very recently, ‘DB pension schemes’ and ‘surplus’ were not phrases often heard in the same sentence.

But recent figures from The Pensions Regulator (TPR) suggests that out of c.5,000 DB schemes, over 3,750 are now in surplus on a low dependency basis with a further 950 schemes approaching surplus.

The aggregate surplus totals a staggering £250bn, roughly 17% of total DB assets[1].

With such eye watering figures, it’s not surprising that the government is consulting with the industry on how to put this money to use. HMRC analysis shows that just £180 million in surplus has been successfully extracted between March 2018 and March 2023. This is largely because most schemes are unable to access surplus except at wind up.

Rule changes

The government is planning to cut the tax on extractions from 35 per cent to 25 per cent and in the Options for Defined Benefit Pension Schemes consultation published at the end of February is looking at introducing a number of statutory overrides to ensure that all schemes can “choose to share surplus subject to the appropriate funding levels.”

The aim of these rule changes would be to encourage schemes to “invest for surplus in productive asset allocations.”


What do pension schemes think?

At the moment, surplus generation is not an objective for Trustee boards. From the sponsor’s perspective, it’s something to be actively avoided as, in most cases, it becomes ‘trapped’ in the scheme as the current legislation means there are very few circumstances where this excess funding can be accessed.

To understand what schemes thought about the proposed changes, Brightwell commissioned mallowstreet to conduct research with 27 pension schemes with over £1bn AUM. The full research can be read in the Endgame Strategy & Priorities Report 2024 here.

More than half of Trustees report that scheme surplus cannot be returned except on wind-up. Just one in ten have such an ability, and a similar proportion are thinking about making this possible.

The majority of schemes (70%) said that a change to the tax rules on surplus would not result in any  change to their investment strategy. Just one in ten say they would stay invested in growth assets for longer.

Given the fact that the majority of UK DB schemes are closed to new members and very mature, it’s unsurprising that schemes are reluctant to introduce greater investment risk into their portfolios. These schemes are largely adopting a cash flow matching strategy that reduces dependency on their sponsors and this approach is unlikely to change fundamentally. But would a change to the rules on surplus have any benefit for sponsors and members?

More than half of Trustees report that scheme surplus cannot be returned except on wind-up. Just one in ten have such an ability, and a similar proportion are thinking about making this possible.


The risks and benefits

Making it easier for surplus to be returned to sponsors may be helpful in giving them greater comfort on avoiding risks of overfunding. It could also allow greater investment in their own business priorities – productive finance in a more direct way.

From the Trustee perspective, it could provide the ability to make discretionary one-off payments to members.

But the challenge comes with answering the question of ‘when is a surplus a surplus?’ Scheme funding is only ever a snapshot in time and the recent volatility shows that some unhedged schemes can easily swing from deficit to surplus in a relatively short period of time.

As such, Trustees would need very clear guidance on how surplus should be assessed and on what basis.

Setting the bar too high (solvency or a buy out basis) reduces the likelihood of funds ever being returned. But set it too low and this could cause problems with schemes paying out surplus one year and being underfunded the next.

As with most things in the pensions world, there’s a risk that this could turn into a costly and complex exercise for Trustee boards. That needs to be avoided.

If the government want to increase pension scheme’s investment in “productive assets”, changing the rules around surplus is unlikely to make a difference. But providing more flexibility around surplus intuitively feels like a good thing. Ultimately, whichever way the government advances its proposals, it’s imperative that Trustees, and sponsors are clear on the rules to follow.


If you are interested in finding out more about how Brightwell can develop innovative solutions for your scheme, please contact us at hello@brightwellpensions.com.

[1] Options for Defined Benefit schemes – GOV.UK (www.gov.uk)


Avatar photo

Written by:

Morten Nilsson

Chief Executive Officer (CEO)

Read Time:

6 minutes

Published:

20 / 03 / 2024

Share Article:


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