HL UK Pensions Law Digest 2 June 2025

Welcome to our latest update, in which we cover: 

• The DWP’s consultation response to Options for defined benefit (DB) schemes: 
  • Surplus extraction from DB schemes 
  • Proposals for a public DB consolidator 
• The government’s plans for defined contribution (DC) investment:  
  • Increasing DC investment in productive assets
  • A new size (scale) requirement for DC default funds 
  • Allowing without-consent transfers from contract-based arrangements. 

Options for defined benefit schemes: overview and extraction of surplus 

The DWP has issued its long-awaited response to consultation on options for defined benefit (DB) schemes. The consultation was launched in February 2024 by the previous government but its key proposals have been carried forward.

The response confirms that: 

• Provisions to ease the extraction of surplus will be included in the Pension Schemes Bill 2025; 
• Further work will be undertaken on proposals for a public consolidator for DB schemes but provisions will not be included in the Bill (for more details please see the next article); and 
• Proposals to allow schemes to opt in to PPF protection for 100% of scheme benefits in return for a higher levy will not be taken forward, on grounds of high cost and the risk of moral hazard. 

Key points in relation to surplus extraction are as follows:

Extraction of surplus: scheme rules 

• Trustees will be given a statutory power to amend their scheme rules by resolution to permit surplus sharing. 
• Use of the power will be at the discretion of the trustees, taking into account their scheme’s particular circumstances. 
• Trustees will not be given a statutory power to make surplus payments – any surplus extraction will be under powers in the scheme rules (as amended if the trustees think fit). 

Extraction of surplus: minimum funding level and member protection 

• The government is minded to lower the funding threshold for release of surplus to full funding on the low dependency funding basis, rather than the current full buyout funding level. 
• Details of funding requirements for surplus release will be set out in regulations, which will be subject to consultation. 
• The Pensions Regulator (TPR) will develop guidance for trustees on surplus extraction. The government expects trustees to take wider considerations (such as the employer covenant and any benefits for members) into account when deciding whether to pay surplus to an employer. The guidance will include a suite of options for trustees to benefit members when sharing surplus. 
• The government will not mandate how extracted surplus must be used. Trustees will remain responsible for negotiating with employers about possible benefit improvements. 
• Extraction of surplus will be subject to trustee discretion and actuarial certification. 

Extraction of surplus: current legislative barriers 

• Section 37 Pensions Act 1995 will be amended to clarify that when exercising a power to extract surplus, trustees must act in accordance with their overarching duties to beneficiaries. These overarching duties will not be changed. At present, section 37 provides that trustees may only pay surplus to an employer if they are satisfied that this is “in the interests of the members”, which has led to uncertainty over whether this requirement is additional to trustees’ underlying duties. 
• Currently, surplus may only be paid to employers if the trustees passed a resolution under section 251 Pensions Act 2024 before April 2016. This requirement will be repealed.

Extraction of surplus: taxation 

The 25% tax rate will continue to apply on surplus extraction. The government comments that it is continuing to consider the tax regime for surplus extraction. (There are currently disagreements between industry and HMRC over whether the 25% tax applies to the amount of surplus actually returned to an employer or to the grossed up amount paid.) 

[Back to top]

Options for defined benefit schemes: public consolidator 

The government response to consultation on Options for defined benefit (DB) schemes confirms that the Pension Schemes Bill will not provide for the establishment of a public consolidator for DB schemes. 

However, the government is continuing to explore key areas in relation to a future consolidator. Points to note about the government’s thinking are as follows. 

Public DB consolidator: proposed model 

• The public consolidator would be run by the Board of the Pension Protection Fund (PPF) and might share some common infrastructure with the PPF. However, consolidator funds would be ring-fenced from PPF funds. 
• In terms of funding and investment, the consolidator might operate as a single pooled fund on a “run-on” basis, subject to a prudent funding standard, rather than targeting buyout. It would be expected to maximise economies of scale; take advantage of new investment opportunities; and improve standards of governance. 
• Various other aspects of a public consolidator are still being considered, including: 
  • Whether schemes should standardise member benefits into a pre-determined structure on entry to the consolidator; 
  • How any surplus in the consolidator might be used; and 
  • The approach to underwriting the consolidator. 

Public consolidator: eligibility 

• A consolidator would be accessible to private sector DB schemes which have closed to future accrual and which meet certain eligibility criteria. 
• When considering eligibility criteria, the government is aware that: 
  • Many employers will continue to seek buyout for their DB schemes; 
  • Small schemes are increasingly able to access the buyout market; and 
  • For schemes unable to access buyout, a growing superfund market may give a viable alternative. 
• The government comments that a consolidator could provide a helpful option for schemes with funding levels of 75% or less and which are unlikely to be able to access commercial consolidators. It is exploring whether a consolidator would be beneficial for a wider range of schemes, for example small DB schemes which are well-funded. 
• However, the government is keen that a public consolidator should not compete with existing options for DB schemes, and this will factor into decisions about eligibility. 

Public DB consolidator: funding commitments from sponsoring employers 

• The government wants to prevent the consolidator from becoming a cheaper option for sponsoring employers than continuing to support their scheme independently. Accordingly, the entry price for a scheme entering the consolidator is likely to be: 
  • Based on the consolidator’s funding standard; and 
  • At least as great as the cost of meeting the scheme’s long term funding objective. 
• Where an underfunded scheme enters the consolidator, the sponsoring employer will need to commit to making good the funding deficit up to the entry price level, in accordance with a schedule of contributions. 
• When the sponsoring employer has met all payments under the schedule of contributions, it will cease to have further liability for the scheme.
• If the sponsoring employer becomes insolvent before paying off the funding deficit to the consolidator, the consolidator would be able to reduce benefits. 

[Back to top]

Investment by defined contribution schemes: Investment Review 

The government has issued the Final Report of its Pensions Investment Review, which was launched on 24 July 2024 in the immediate aftermath of the general election. The Final Report follows an Interim Report in November 2024. 

Alongside the Final Report, HM Treasury and the DWP have issued their response to consultation on Unlocking the UK pensions markets for growth. 

The Report and the consultation response overlap significantly in terms of policy intent for defined contribution (DC) schemes and investment. As expected, the focus is on improving value for savers and increasing opportunities for investment by DC schemes in productive assets.

Key areas covered in relation to private sector pensions are:

• Increasing DC investment in productive assets
• A new size (scale) requirement for DC default funds 
• Allowing without-consent transfers from contract-based arrangements. 

The Final Report also confirms that: 

• The government will proceed with proposals for minimum standards of asset pooling within the Local Government Pension Scheme (LGPS); and 
• Phase Two of the Pensions Review will be launched “in the coming months” and will focus on retirement adequacy and saver outcomes. 

[Back to top] 

Defined contribution (DC) investment: productive assets 

DC investment in productive assets: no mandate yet but a reserve power 

• The government has decided against mandating how DC assets should be invested at present. This decision follows the recent Mansion House Accord (in which 17 major DC providers voluntarily committed to investing 10% of their main default funds in private markets, including 5% in the UK). 
• However, the Pension Schemes Bill will include a reserve power which could be activated in future to require pension schemes to meet quantitative targets for investment in private assets, including in the UK. 
  • The government does not expect to exercise this power unless it believes the pension industry has not delivered change voluntarily, following the commitments made in the Mansion House Accord. 
  • The reserve power will include safeguards for savers and it is intended that any requirements would be consistent with fiduciary duties. 

Productive assets: transparency on DC asset allocation 

• The Pensions Regulator (TPR) and the Financial Conduct Authority (FCA) will launch a data-collection exercise later this year, intended to include data on asset allocation. 
• Major DC providers will be asked to provide asset allocation information, broken down by asset class and sub-asset class, and including how assets are splits between UK and overseas investment. 
• First reporting from the data-collection exercise is expected in early 2026. 
• The exercise will be run annually until data from the Value for Money (VFM) Framework becomes available, which is expected to be from 2028. 

Productive assets: pipeline of investment opportunities 

The Final Report includes a chapter setting out steps being taken to ensure that there is a pipeline of opportunities across the UK which are suitable for pension scheme investment. 

[Back to top]

Defined contribution (DC): size requirements for default funds 

The Consultation Response and the Final Report set out the government’s plans to accelerate the development of large DC default funds used for auto-enrolment (AE), with a corresponding reduction in the number of smaller default funds. 

Scale requirement for DC default funds 

• The Pension Schemes Bill will require every multi-employer AE scheme or provider in scope to have at least £25bn assets under management (AUM) in their “main scale default arrangement” by 2030. 
• The £25bn AUM requirement will apply at the arrangement level. Details of what a “main scale default arrangement” comprises will be set out in regulations and will be subject to consultation. 
• A “transition pathway” will be available to a provider or Master Trust which: 
  • Will have at least £10bn AUM in one main default arrangement by 2030; 
  • Has a robust and deliverable plan to grow its main default fund to £25bn by 2035; 
  • Meets certain quantitative and qualitative conditions set out in regulations (likely to include a target level of investment in productive / UK assets and benchmarked fees); and 
  • Applies to regulators in 2029 for access to the transition pathway. 
• Schemes which do not meet the scale requirements by 2030 (or 2035 if on the transition pathway) will have to exit the AE market. Future AE contributions must cease and such schemes should consider winding up or consolidation. 

DC scale requirement: which schemes are in scope? 

• Some types of scheme will be exempt from the scale requirements. The consultation response is not clear in all respects, although some wording suggests that the requirements will apply to AE Master Trusts and contract-based pension providers. The following may be exempt: 
  • Single-employer pension schemes; 
  • Schemes with connected or concurrent defined benefit (DB) accrual; 
  • Schemes for employers in the same industry or profession; 
  • Schemes which cater solely for a protected characteristic, such as religious belief; and 
  • Collective defined contribution (CDC) schemes 
• The government documents lack clarity on whether the scale requirements will apply to a non-commercial multi-employer AE scheme for employers in the same corporate group. It would make sense, and seem in line with government policy, for such a scheme to be exempt. 

DC scale requirement: investment capability 

• Pension providers and Master Trusts subject to the scale requirement must also demonstrate that they have, or are building, investment capability appropriate for their size. This will include having suitably qualified in-house investment expertise and strong governance. 

DC scale requirement: reducing non-main scale AE default funds 

Providers or schemes in scope will not be limited in how many non-main scale AE default funds they operate. However, the government will implement a three step process to reduce the number of non-main scale default funds delivering poor value. 

• Step 1 (2028): providers and schemes should proactively consider consolidating non-main scale default funds into their main fund, and should consolidate unless this is not beneficial to savers’ interests or other justifications apply; 
• Step 2 (2029): a Ministerial-led review will commence, following the implementation of the Value for Money Framework (VFM) and the contractual override (see below), to explore why any default arrangements remain outside main scale default funds. A legislative underpin to address remaining fragmentation will be introduced if needed; and 
• Step 3 (2030 onwards): assessment of any further action required. 

DC scale requirements: innovation and new default funds 

• When the new requirements are in place, creating and operating a new default fund will require regulatory approval. 
• A “new entrant” pathway will be introduced, to allow new market entrants with innovative products to seek authorisation. 
• Conditions for approval will be consulted on and will be set out in regulations, but are expected to include that the arrangement is necessary to meet: the needs of a protected characteristic; an ethical need; or the need of an employer to manage conflicts of interest. 

DC default funds: differential pricing 

• The consultation considered whether a single price should be required for a default fund rather than (as at present) permitting different fees to be charged for the same fund. 
• The government has decided not to require a single pricing structure at present but will undertake further analysis following the implementation of the VFM Framework and other reforms. 

[Back to top]

Contractual override for without consent transfers from contract-based funds 

The Final Report and the consultation response set out plans to permit contract-based arrangements to transfer out savers without their consent, to facilitate greater consolidation of the DC default market. Currently, trust-based schemes may transfer members without consent (subject to certain conditions) but this is not usually possible under contract-based arrangements. 

Contractual override power 

• The Pension Scheme Bill will introduce a contractual override power, to allow transfers from contract-based funds without consent, subject to various member protections. 
• Detailed rules on the operation of the override will be made by the Financial Conduct Authority (FCA). 
• Occupational pension schemes which receive without consent transfers from contract-based arrangements will continue to be regulated the Pensions Regulator (TPR). The government and TPR will consider whether any amendments to regulations or guidance are needed to clarify the role of receiving schemes. 
• The contractual override will initially apply to workplace pensions. However, regulations could extend the power to non-workplace pensions at a future time. 
• The contractual override mechanism will also be used where a provider is required to move savers to another arrangement under the Value for Money (VFM) Framework. 

Contractual override: protections for savers 

• Before using the contractual override, the provider must obtain a positive assessment from an independent third party who has sufficient expertise and meets specified requirements.
• A savers’ best interests test will be set out in legislation. The independent assessment must certify that the provider has met the best interests test and complied with relevant processes and safeguards. 
• Where a provider proposes to transfer savers to another of its own funds, it should consider the full range of its arrangements, including any Master Trust it provides, when deciding the destination fund and should transfer to the fund which gives best value.
• The provider may be required to notify the FCA of the proposed transfer, as well as the savers and any active employers. 
• Savers will have the right to opt-out of the transfer and to select an alternative receiving arrangement. 
• Redress will be available for savers if procedural requirements are not followed or in cases of negligence or bad faith. However, providers and independent assessors will not be liable for worse outcomes for savers resulting from market movements. 

Contractual override: costs 

• The government intends that the majority of transfer costs will fall on providers, not on savers. 
• However it recognises that some costs (such as transaction costs on the purchase or sale of assets) may be indirectly borne by members. Such costs should be taken into account when considering if the best interests test is met. 

[Back to top]

Authored by Jill Clucas.