DB surplus and DC: what’s possible, what’s practical, what’s next?

Passing the DB ball to DC

Only a few years ago, many DB schemes were wrestling with deficits and long‑term funding challenges. Today, thanks to market movements and maturing schemes, the picture is different: a growing number are running in surplus, prompting fresh conversations about how those funds might be redeployed.

One emerging trend is the desire to use DB surplus to enhance DC provision. For many, this is becoming a feature of scheme design, with the potential to ease contribution costs while boosting value for pension scheme members.

Regulatory change is opening the door to more responsible uses of scheme surplus, with many now considering it as part of their DB endgame. As with any endgame, the key lies in understanding the rules and setting the right strategy.

In our view, there are three main surplus options to consider. They are own trust and hybrid trusts, master trust (with member transfer) and master trust (without member transfer).

Own trusts and hybrid trusts: the simplest route

Where a hybrid trust exists – with DB and DC sections under a single trust – using surplus is relatively straightforward. Because no pension transfer is required, the surplus can be redirected to offset DC contributions with minimal complexity. Employers can apply surplus to all members, including new joiners, and adjust or stop payments as funding positions change.

This also provides flexibility for future transitions. If a DB section is approaching buy-in or winding down, the DC section can be moved to a master trust in due course, with the surplus use tapering off as needed.

Master trusts: opportunity with added considerations

Transferring surplus into a master trust brings greater governance considerations. Here a recognised pension transfer of a member is required, and the mechanics of that transfer depend heavily on the starting structure.

Where a hybrid of own trust and master trust already exists, it may be possible to transfer both member assets and surplus together, using the master trust (with member transfer) option. Surplus in this scenario typically supports contributions for the transferring membership only. Future surplus may be more challenging to transfer.

For employers without a hybrid trust – for example, those using a contract-based DC arrangement – things become more layered. Under the master trust (without member transfer) route, trustees and legal advisers must consider how to establish the necessary link between DB and DC scheme members without triggering an unauthorised transfer. Potential transfer routes include using common member populations as a basis for transfer or setting up members in DB scheme then transferring with surplus. These both require careful navigation.

In determining the right option, schemes should start with the rules, the legal advice and a clear understanding of the endgame. When surplus transfers are involved, getting the groundwork right is essential.

End goal for pension savers

While the governance behind surplus transfers can be intricate, the potential benefits for members are clearer. Employers are considering using surplus to:

• Increase employer contributions for all members
• Raise the baseline contribution rate above auto enrolment minimums
• Update pensionable pay definitions to improve long-term savings levels

These decisions vary by employer, but each option can help improve retirement outcomes when introduced responsibly and with the long-term picture in mind.

Pivotal point in the game 

As the market continues to evolve, DB surplus is likely to remain a live topic for employers, consultants and trustees alike. With careful planning, it presents a valuable opportunity to enhance DC provision at a time when good member outcomes matter more than ever.

There is a growing need for joined‑up, cross‑scheme thinking. When managed responsibly, DB surplus can play a role in strengthening DC provision and improving retirement adequacy across generations. The choices made by the industry in the years ahead have the potential to create real and lasting value for pension savers.

For information on how L&G is facilitating DB surplus transfers to DC schemes, please read our press release. This solution supports long‑term retirement adequacy and reflects our commitment to joined‑up thinking across pension strategies. As a whole‑of‑market partner supporting DB and DC schemes of all sizes, we believe L&G is well placed to help schemes release surplus – whether that’s on buyout or as part of a run‑on strategy.

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