DB surplus: a trustee’s anxiety of choice (and how sponsors can help) (Part 1)

The Pension Schemes Bill’s surplus refund provisions have focused more attention on surpluses in DB schemes. But DB surpluses were already high on the agenda. With the Regulator's 2025 Annual Funding Statement estimating that 85% of DB schemes are in surplus on a technical provisions basis and 54% in surplus on a buyout basis, many sponsors and trustees have already been doing a lot of thinking about their options in relation to surplus – including some whose schemes are not yet in surplus. 

Much of this thinking focuses on ways of getting value from surplus as part of a “run-on” strategy – where, instead of buying out the scheme benefits, the scheme trustee continues to invest assets and to pay benefits, and the sponsor continues to bear ultimate responsibility for ensuring that the scheme has sufficient funding to provide those benefits. In a departure from what previously seemed to be an unstated assumption that every DB scheme should be headed to buyout as quickly as possible, the Pensions Regulator’s recently-issued guidance on new models for DB schemes now encourages trustees and sponsors to look at a wide range of options when endgame planning – one aspect of a marked change in the political and regulatory mood related to pensions.

The Bill promises to broaden significantly the options for a run-on by making it easier to make refunds of surplus to sponsors from ongoing schemes (I’ll refer to this as the “refund route”). Extracting surpluses from ongoing DB schemes has often proved difficult due to trust law considerations and restrictions in the terms of particular schemes’ trust deeds. Indeed, I have never seen it being done in practice. For many schemes, making such refunds will become legally possible for the first time due to these changes. 

However, the Government’s roadmap to its pensions reform programme says that the surplus refund provisions of the Bill, and the regulations to be made under them, will not come into force until 2027. So, for the time being, many sponsors and trustees will continue to explore the use of surplus to meet DC costs in an ongoing scheme (which I’ll refer to as the “DB / DC route”). 

In this first of a two-part blog, I will take a look at the considerations specific to each of these options, before turning in my next blog to the key issues common to both.

Navigating the DB / DC route

The DB / DC route was first taken by employers and trustees in the 1990s, when surpluses were common. There was initially some uncertainty as to whether it was permissible – with the High Court taking a restrictive approach in 1999 in Kemble v Hicks (No. 2). It wasn’t until the 2000 decision of the High Court in Barclays Bank v Holmes that the DB / DC route was put on a secure legal footing. 

The Barclays decision has provided the legal basis for the DB / DC route ever since, with care usually being taken to ensure that the use of surplus is consistent with the rules under which DC benefits are provided. In particular, the terms of the trust should not segregate DB from DC or mandate that cash contributions be paid – typically, reliance will be placed on the ability to “credit” the relevant amounts to members’ DC accounts or similar. 

But while the trust law principles have remained stable and well-understood over the past 25 years, plenty of other things have changed. When going down the DB / DC route, thought needs to be given to such matters as:

• DC requirements: many employers do not have an active DC section in the scheme that contains the DB surplus – often because the DC arrangements were previously transferred out to a commercial master trust or GPPs were used for future service and new joiners. If DC arrangements are to be brought (back) into the DB scheme, ideally the trustee board will have experience of managing DC benefits and the support necessary to meet the additional governance requirements that apply. The trustee and sponsor will also need to consider the impact of the Bill’s long-trailed value for money (“VFM”) requirements, and whether the scheme will be able to justify its continuing provision of DC given the increasing expectations in relation to quality, performance and cost efficiency and the VFM metrics that the DC offering will be assessed by in the future. Some DC master trusts have been developing innovative solutions to this problem by allowing DB surplus to be transferred-in to offset ongoing employer DC contributions to the master trust. This solution, however, raises a range of trust law and tax considerations which will need to be carefully worked through. 
• Tax: for many sponsors, part of the appeal of this route is that it ought not to trigger a 25% authorised surplus payments charge under the Finance Act 2004 (“FA04”).  However, there are a number of ways in which unauthorised payments and tax charges can potentially arise under the FA04, which can be quite fact-specific in their application. These will need careful consideration before going ahead with implementation. 
• Auto-enrolment: a final consideration is whether using surplus to meet DC costs is consistent with an employer’s statutory obligations to make contributions under auto-enrolment legislation. 

The refund route – clearing obstacles off the path

It’s typically been a far more challenging exercise for an employer to receive a payment of surplus out of an ongoing scheme. Many foundational pensions law cases (such as Courage, Imperial Tobacco and Hillsdown Holdings) related to proposals to extract surpluses from DB schemes – and quite a few of those proposals fell foul of restrictions in the schemes’ trust deeds or other trust law considerations such as whether powers were being exercised for a proper purpose. Much depended on the precise terms of a scheme’s power of amendment or provisions addressing surplus, which were often introduced decades ago in very different circumstances – and to this day those terms will shape whether the refund route is permissible or not for particular scheme, a situation often called the “drafting lottery”.

Since April 1997, section 37 of the Pensions Act 1995 (“Section 37”) has also imposed significant statutory hurdles to surplus extraction: 

• A requirement, introduced in 2006, that the scheme be funded above buyout level. For a long time, this was very rare – a combination of previous minimum funding requirements being less onerous and, post-2008, the ultra-low interest rate and yield environment. That has changed with the rise in interest rates and gilt yields since 2022, leading to the widespread emergence of material surpluses. However, the terms of schemes’ trust deeds has remained a common problem, such that the DB / DC route has been easier to take.
• A requirement that a surplus refund can only be made if the scheme trustee is satisfied that the payment is “in the interests of the members”. This test goes beyond what is strictly required by trust law. In practice, it can readily be viewed by trustees as an obligation to obtain some positive benefit for scheme members, such as an enhancement to their benefits. 
• Section 251 of the Pensions Act 2004 also made it necessary for a trustee to have passed a resolution before 6 April 2016 (a “Section 251 Resolution”) in order to make a refund of surplus whilst complying with Section 37.

The Bill will transform this position:

• It will introduce a statutory power for a trustee to amend a scheme by resolution so as to enable the payment of surplus out of the scheme to an employer, and to remove any restrictions on making such payments that may be in the scheme rules. This will allow trustees and sponsors to overcome the drafting lottery. 
• Section 37 will be changed so that while the trustee will still need to agree to the payment of surplus to the employer it will no longer be obliged to satisfy itself that the payment is in the interests of the members. The requirement to have passed a Section 251 Resolution will also be removed. 

These changes will mean that a trustee decision on whether to make a payment of surplus to an employer, including any decision to amend the scheme to enable such a payment, will be governed by basic trust law duties that apply on the exercise of a discretion by a trustee – whether the power is being exercised for a proper purpose, whether relevant considerations (and only such considerations) are being taken into account, the fiduciary duties of loyalty, and so on. 

As such, the Bill will go a long way towards levelling the playing field as between the DB/DC route and the surplus route once it comes into force in 2027. However, will more choice lead to greater anxiety for trustees? In my second blog, I will explore the key issues that are common to both routes – issues which will lie at the heart of any decision by sponsors and trustees on whether to run-on or not.