How can employers benefit from pension scheme surpluses?
How can employers benefit from pension scheme surpluses?
17 Dec 2024
Many defined benefit (DB) pension schemes are better funded than ever before. As part of the new requirements for schemes to set a long-term objective, employers are taking the opportunity to bring surpluses to the discussion and understand how it may be extracted and used.
This edition of XPS Express is the third in a series on setting long-term strategies - read parts one, two, four and five here. Explore our latest insights on the DB surplus proposals here.
At a glance
- There is an estimated total surplus of c.£200bn across all UK DB schemes which is expected to grow further in future.1
- The Government has been consulting on the topic of surplus - to potentially make it easier for employers to extract it. This presents opportunities for employers.
- Whether you choose to run on in the long-term, or in the short-term ahead of an insurance buyout, employers can consider how to generate surpluses to be extracted and used in an effective way as part of their long-term strategy.
- Any surplus extracted can support the employer’s wider business objectives and create value for both the employer and scheme members.
1. Source: XPS DB:UK Funding watch, 28 November 2024.
How can pension scheme surplus be used?
|
Option |
Explanation |
| Use it to subsidise DB or DC costs | Subsidise DB accrual, improve funding for other DB schemes, pay DC contributions |
| Refund of surplus | Cash is returned to the employer subject to 25% tax |
| Improve member outcomes | Provide discretionary benefits, enhanced member options, IFA support |
| Facilitate corporate activity | Support business restructuring, improve creditworthiness |
Recent XPS survey:
If you had a material surplus in your DB scheme how would you use it?
Generating value for employers
- With the appropriate strategy it is possible to extract stable amounts of surplus in future years – which can be very valuable to an employer.
- By projecting the potential future surplus over time under different strategies, employers can assess the overall value and risks of running on the scheme, in the context of their own business.
- As an example, a c.£300m scheme could safely extract a steady £5m pa of surplus over the next 20 years once an appropriate strategy is implemented.
Actions employers should take
- Determine your scheme’s current funding position and how surplus may emerge over time. XPS can produce projections for you to help with this.
- Define your objectives with scheme trustees to agree on how you intend to generate and use the surplus in a risk-controlled way.
- Agree a suitable strategy for surplus extraction within your risk tolerances – consider a surplus framework such as the one overleaf.
How employers can generate and extract surplus
There are many potential routes to extract surplus in the short to medium term, with various interlinking factors to consider. The sample framework below helps guide employers to create a scheme-specific strategy that meets the objectives of all stakeholders, focusing discussions on the important levers and metrics.
This is broken down into distinct steps to facilitate easy comparisons between different strategies, so employers can better assess the value of running on their schemes. Employers can then decide with their trustees how to use this surplus to meet their objectives.
Sample framework
Case Study: DB scheme employer extracts surplus
We helped an employer with a material surplus in their scheme who did not want to use insurance:
| Employer's objectives | How we helped | Outcome |
|
Minimise the risk of having to pay contributions into the scheme again |
Compared level of surplus expected to be extracted each year under different investment strategies |
Decided a large buffer is needed to manage risks |
|
Consistent level of surplus extracted each year |
Analysed how shock scenarios could cause a deficit and require contributions in 5% of outcomes |
Agreed to adjust the investment strategy for greater stability and protection against market volatility |
|
Fair outcome for company and members |
Ran a workshop to facilitate discussion with trustees |
Employer and trustee are working together to set up a mechanism to share surplus equitably |
Find out more
For further information, please get in touch with Amy Farrell, Charlotte Yuen or Dan Auton or speak to your usual XPS Group contact.
Related links
Download our June 2025 XPS Express on the proposals to make DB surplus more accessible to employers
Part 1: The Pensions Regulator's new funding code for employers
Part 2: Setting long-term objectives
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