How the UK government aims to use pensions for economic growth

Economic growth is a well-publicised priority for the government. In short, it is seeking more money to be invested in the UK and to help grow the economy, and pension scheme assets are seen as a potential source. This has led to a number of proposed reforms to the UK pension system.

In the Defined Contribution (DC) context, the past few years have seen various consultations advocating the benefit of scale (ie the bigger the better) for both individuals and the economy as a whole. The government seems clear in its belief that the future of workplace DC schemes is in “fewer, bigger, better run schemes” that can “deliver better returns” and “boost investment in the UK.” 

The importance of scale has been a key factor in DC pension provision since auto-enrolment first took off in 2012. However, scale does now seem to be becoming a dominant feature underpinning a lot of DC discussions.

By consolidating DC schemes, the government hopes to create a situation where DC pension money can be used to better effect. In this regard, they have been looking to Australia and Canada for ideas, in particular considering how consolidation has affected the economy in those countries.

The drive for DC consolidation

The government recently announced two new measures designed to accelerate and help enable scale and consolidation in the UK DC market. Firstly, introducing minimum size requirements for DC default arrangements in multi-employer schemes used for automatic enrolment (along with limits on the number of such arrangements), and secondly, overriding individual contracts to allow bulk transfers of assets from contract-based schemes without individual savers’ consent.

With so many important changes due to take place, trustees and employers should keep a close eye on the DC horizon over the course of the year. 

The focus on growth isn’t just restricted to the DC side of the fence. On 28 January 2025, the government also announced plans to lift restrictions on how well-funded, occupational Defined Benefit (DB) schemes that are ‘performing well’ will be able to invest their surplus funds. The government is clearly mindful that DB schemes could collectively offer vast potential to not only support their own members and their sponsors, but also the wider UK economy. To this end, we have already seen a reduction in the rate of tax payable by employers on surplus repayments from 35 percent to 25 percent which took effect from 6 April 2024.

Although the DB funding regime recognises a degree of scheme-specific flexibility, the emphasis on being fully funded has driven many DB schemes to de-risking their investments over the last few years.

Although the DB funding regime recognises a degree of scheme-specific flexibility, the emphasis on being fully funded has driven many DB schemes to de-risk their investments over the last few years.

 Many in the pensions world take the view that the ‘gold standard’ in terms of end game is to secure (or buy-out) the schemes’ benefits with an insurance company. But some commentators now take the view that, for schemes with healthy surpluses, such an approach may be overly prudent and could deprive the UK economy of capital that could generate growth.

Unlocking DB surpluses for growth

Last year, the DWP consulted on proposals to make it easier to make payments from DB scheme surplus to sponsors and scheme members, intended to “balance enhanced options for DB scheme trustees with prioritising the security of member benefits.” Options on the table in relation to facilitating the release of surplus to employers, included a statutory override either in the form of a power to amend scheme rules to allow for payments or a statutory power to make surplus payments. 

The eligibility criteria for any surplus extraction would be based on factors such as funding levels and employer covenant strength so as to safeguard member benefits. The idea of a Pension Protection Fund (PPF) ‘super levy’ has also been suggested as a way to facilitate surplus extraction, in exchange for securing 100 percent PPF compensation in the event of a subsequent employer insolvency. 

All of this could potentially encourage employers to consider running on their schemes. There is scope here for fundamental changes to the way in which employers view their legacy DB schemes, transforming them from liabilities to be offloaded at the earliest opportunity into valuable assets worth running on for a longer-term benefit. It will be interesting to see whether this changes the perception of companies with DB pension liabilities. 

For example, in an M&A context, in previous years an employer that sponsors a DB pension scheme may not have been seen as an attractive target. In the future, there might be potential for the opposite to be true. 

Challenges in extracting DB surpluses

Turning to potential issues around the mechanics of extracting surplus, assets in DB occupational pension schemes are held under trusts. As such, when exercising any power, the trustees of those schemes must go through a two-stage process. Firstly, can they exercise a power? Secondly, should they exercise that power? 

Depending on the ultimate scope of any new statutory powers, simplifying the process for extracting surplus from DB schemes may help with the first step (can you?) but not necessarily the second (should you?). In terms of the second step, trustees of DB schemes are generally required to act in the interests of their members. In this regard, there is already a well-established body of case law surrounding the distribution of surplus and the exercise of trustee duties. 

While the particular factors to consider may vary depending on whether a DB scheme is ongoing or in wind up, this line of cases is likely to continue to be relevant. The main concern for trustees will be that any extraction of surplus will potentially reduce the security of members’ promised benefits. 

In the past, many employers reduced the level of benefits provided by their DB pension schemes (before ceasing accrual altogether) and/or increased member contribution levels. As such, members may well have their own ideas about how any surplus is now used.

The future of DB schemes

The government’s consultation has suggested maintaining the current balance of power between a sponsoring employer and the scheme’s trustees where possible. However, this could be difficult as several provisions might be in play (eg a power to return surplus on an ongoing basis versus wind-up, as well as the scheme’s amendment power) and each might contain a different power balance. It is also worth noting that some scheme rules do not contain a surplus power at all and/or have a restriction in the amendment power preventing a surplus rule being introduced.

Details of the government’s surplus policy will be included in the DWP’s response to its DB options consultation, which is expected to be published in the spring. As around “75% of schemes are currently in surplus, worth £160 billion,” this will be a key development for DB schemes and their advisers to monitor closely.