The funding position of many schemes is now above the buy-out level, a situation that previously had been seen only as a long-term aspiration for many trustees and employers.

Market innovation has brought new products such as superfunds, and several new insurers offering bulk annuity contracts. Trustees are now expected to explicitly consider the future prospects for pension schemes, and to develop a policy, to manage what is being termed the endgame.

Added to this, the Pension Schemes Act 2026 paved the way to allow surplus sharing between employers and scheme members. New draft surplus regulations from the Department of Work & Pensions (DWP) setting out conditions for surplus release are currently out for consultation, until 2 September 2026. Subject to consultation responses, it is expected the new surplus flexibilities will be available from April 2027.

The Pensions Regulator issued guidance on surplus flexibilities in June and also on new models guidance, with a further update expected once final surplus regulations have been made. Given all this new information, how should trustees assess their options and duties on dealing with surplus?

One key aspect is the size of scheme in terms of assets and liabilities in the context of the current funding level.

For many closed schemes, the future administrative cost of running on the scheme even with the prospect of return of surplus will not be appealing against the option of fully winding up the scheme without any additional further employer contributions.

Avoiding future running costs and the risk of future employer contributions would usually be more compelling for a small legacy scheme. In this event members and the employer may still benefit from any residual surplus on winding up depending on the scheme’s formal provisions and the any agreements reached on this by the trustees and employer.

Where the trustees consider running on the scheme is feasible, thoughts can turn to surplus extraction and utilisation. Annex C to the draft surplus regulations helpfully includes an illustrative five stage process that trustees may find helpful in structuring their policy on surplus.

Some preliminary legal and actuarial checks should be made up front to confirm matters can proceed as planned.

Scheme rules must allow surplus extraction, and a new statutory power is available to amend rules where needed for this purpose.

The scheme’s financial position will need to be checked as the actuary will need to certify that two tests are met. These are essentially that there is a surplus on the given basis and that this is also likely to be the case for the next three years.

Note these are simply statutory minimum threshold checks, and do not in themselves imply any recommendation or actual thresholds for the amount of surplus extraction.

It is expected that in practice trustees will seek to apply higher thresholds having considered other relevant information, such as the strength of employer covenant and the scheme’s investment strategy, where trustees should obtain further advice.

The traditional perspectives from yesteryear can be seen to have changed. Surplus extraction can now be designed to benefit scheme members as well as employers. The benefit payable to members could be in the form of one-off payments and/or uplifting the current level of pensions.

Trustees who are bound to act in members’ interests should therefore not immediately dismiss any proposal for surplus extraction on the grounds that this would not necessarily be in members’ interests, or that it would unreasonably jeopardise the security of scheme benefits.

The classic counterexample is the long-retired pensioner. Someone who would demonstrably benefit more personally from an immediate one-off payment met from surplus extraction rather than what might be viewed as an excessive level of security maintained by retaining this surplus in a very well-funded scheme which is backed by a strong employer covenant.

Trustees will therefore need to consider carefully a range of issues in deciding how to proceed. These issues will include understanding what risks there are with the current employer covenant looking into the future. What risks are there with the current scheme investment strategy and how could these damage the scheme’s financial position?

Another key area will be the funding measures. What is the funding threshold that should be set to assess whether there is any surplus – would this be the low dependency funding basis plus a buffer, or the estimated solvency basis, or something else? Should the trustees be looking for contingent assets to help guard against deterioration?

The ultimate decision is how much surplus should be extracted, how is this to be split with the employer, and how can this be fairly allocated between different classes of member. Surplus can in theory be extracted as a one-off transaction, or as instalments over time which would allow ongoing reviews over future periods.

The trustees will also need to consider the employer’s perspective, not least as it is expected that employer consent will be needed for surplus release. The trustees will be interested to find out if the employer will agree to use its share of surplus in a specified way, for example in a covenant enhancing way.

The employer will have its own views on a reasonable split with members, that it expects trustees can agree to in their proper exercise of their fiduciary duties. The employer may prefer, and only contemplate, a one-off payment rather than smaller regular instalments and the extra administration that would go with this.

Once outline agreement has been reached the trustees will need to follow statutory processes to make surplus payments at an intended date. This will include statutory notice periods to inform members and the Pensions Regulator, meeting the certification and consent requirements, and dealing with the tax issues that follow.

It remains to be seen how much appetite trustees and employers will have for this option, and how the alternatives develop. As this continues to evolve, it will be interesting to see what emerges.

Sarah Bennett, Pension Consultant – Hughes Price Walker