Refund of pension scheme surplus: a clearer picture slowly emerges

For many employers, one of the key provisions of the imminent Pension Schemes Bill is a much anticipated relaxation of the regime allowing for payment of surplus from defined benefit pension schemes to the sponsoring employer, even where the scheme is not being wound up. While we are still eagerly awaiting the publication of the Pension Schemes Bill itself, more details of the approach which government is proposing to take emerged last week, when the government published its response to the consultation on options for defined benefit pension schemes.

The government favours granting a statutory power to amend scheme rules to permit the refund of surplus, rather than granting an overriding free standing statutory power. This may seem like a minor distinction but will potentially allow trustees to take into account the existing balance of power under their scheme rules to a greater extent than might be the case with a free standing power. An amendment to scheme rules could include provisions which are not technically required by the new statutory framework, if the trustees feel that extra conditions or safeguards are needed. In practice we would expect employers and trustees to negotiate, whether on the wording of any enabling power to be included in the scheme rules, or on any conditions which the trustees might require before agreeing to use a statutory power.  Helpfully, it seems that the requirement in the current legislation for trustees to take the view that the refund is “in the interests of members” will be removed. Trustees will still have to be satisfied that any refund does not conflict with their fiduciary duties, and some may take quite a bit of persuasion.  Trustees will need to consider the extent of any risk to the security of member benefits and weigh this up in the light of the employer covenant and any member upside. Helpfully the government does not intend to impose any specific requirements on how any surplus is to be used.

The government has also clarified that the funding condition to allow surplus to be paid a sponsoring employer will be full funding on a low dependency funding basis. This is lower than was initially expected, and will in theory mean more employers may be able to take advantage of the legislation. This does align with the revised funding regime, which requires trustees to be targeting funding on a low dependency basis by the time the scheme reaches significant maturity. Government is also giving more thought to the appropriate tax treatment of a refund surplus but has confirmed that they consider the tax framework to be broadly balanced and fair, and we anticipate therefore that the reduction of the rate of the free standing tax charge payable by the employer to 25% (from 35%) will not be reversed. The response to consultation does however state that the tax regime is under review. 

The detail of the funding threshold will be included in regulations, which will be accompanied by Pensions Regulator guidance on the refund of surplus regime. Even if the Pension Schemes Bill is issued in the next few weeks, we don’t expect the new regime to be in force for some time, not least because of the requirement for consultation on the draft regulations. The government has not yet specified a timescale, but we would be very surprised if the final regime can be in place before October 2026.

If you would like to discuss any of the issues discussed in this blog post, please get in touch with your usual Freshfields contact or any of the authors.