The 2025 Autumn Budget marked a further relaxation in the government’s approach to the treatment of surpluses in defined benefit (DB) schemes.
From April 2027, well-funded DB schemes will be permitted to make lump sum payments to members. Currently, where a pension is augmented from surplus, it will need to be revalued, whilst deferred, and increased annually once in payment. Paying the benefit as a lump sum will mean that a one-off payment can be made to the member instead. Currently, such a payment would be an unauthorised payment and subject to penal tax charges but, under the proposed changes, members will instead be taxed on the lump sum at their marginal income tax rate.
What has changed and why?
For many years, surplus extraction has been tightly constrained. Refunds to employers attracted a 35% tax charge and direct payments to members were not possible. The government began to loosen this position in April 2024 when the employer refund tax charge fell to 25%.
The government has since introduced provisions under the current Pension Schemes Bill allowing trustees to modify their scheme rules to insert a power to return surplus to the employer where there is no existing power or to remove or relax restrictions on any existing power to return surplus. These provisions are expected to come into force in 2027.
The ability to pay lump sums to members from surplus, which was announced in the Budget, will be included in the forthcoming Finance Bill rather than the Pension Schemes Bill.
Taken together, these changes are seen by the government as a way of unlocking capital, supporting employer investment and offering members a tangible share in the strength of their scheme.
The Pensions Regulator’s Annual Funding Statement 2025 estimated that 85% of DB schemes are in surplus on a technical provisions basis and 54% are in surplus on a buy-out basis.
Implications for employers, trustees and members
Employers may find these changes particularly helpful since they will allow them to make one-off payments to members without increasing long-term liabilities – for example, a lump sum payment to active members on closing a scheme to future accrual.
According to HMRC Newsletter 175, a number of conditions will need to be satisfied before payments can be made to members:
- any distribution will require agreement between the trustees and the sponsor;
- schemes must be in surplus on the same funding basis as applies to payments of surplus to employers (this is expected to be on the “low dependency basis” as set out in the scheme’s Funding and Investment Strategy);
- the payment may only be made to members over the Normal Minimum Pension Age (currently age 55 but increasing to age 57 in April 2028); and
- trustees must act in accordance with their duties to protect the interests of scheme beneficiaries.
The lump sum payments will attract income tax at the member’s marginal income tax rate – meaning some members paying tax on these payments at 40-45%.
Aggregate figures published in the Pensions Regulator’s Funding Statement may suggest substantial surpluses across the DB universe, but individual schemes often have more modest positions once longevity, covenant and long-term risk are considered. Trustees and employers will need to consider the impact on the scheme’s funding position going forward, including what safeguards to put in place if funding falls below certain thresholds, any plans to de-risk as well as any provisions regarding augmenting benefits and refunding surplus to the employer on a winding-up.
For trustees, the restriction that the payments can only be made to members over Normal Minimum Pension Age will be a key consideration, given their duties to act in the interests of all scheme members.
What happens next?
The proposed changes regarding payments to members will be legislated for in the Finance Bill
2026-27 and will take effect from 6 April 2027. Guidance from the Pensions Regulator is also expected.
At the third day of the Grand Committee on the Pension Schemes Bill on 19 January 2026, the House of Lords debated a number of amendments testing how far the provisions relating to payment of surplus to employers should be constrained. We are likely to see further developments here.
Lucy Cleary is a Trainee in the Dentons Pension team, based in the London office – for any further queries in relation to the above, please contact lucy.cleary@dentons.com
