Pensions Bulletin 2025/04

Government to enable surplus extraction from DB schemes

On 28 January 2025 the Prime Minister along with the Chancellor announced, ahead of an industry roundtable they held on the same day, that the Government intends to legislate to enable surplus from DB schemes to be paid to employers or to be given to scheme members as additional benefits. Stating that “approximately 75% of schemes are currently in surplus, worth £160 billion, but restrictions have meant that businesses have struggled to invest them”, this announcement forms part of the Government’s growth agenda as it has concluded that such surplus extraction will allow employers to invest in the wider economy.

In notes to the announcement it is stated that “Currently DB scheme surplus can only be accessed where schemes passed a resolution by 2016, so not all schemes can access surplus even if trustees and sponsors both want to do so.”

This appears to indicate that the Government intends to make legislative changes so that those DB schemes that hadn’t passed a surplus resolution by 6 April 2016 under section 251 of the Pensions Act 2004 (see Pensions Bulletin 2015/38) and so cannot currently access surplus, will be able to do something so that they can.

The notes also state that “Legislative changes could enable all DB schemes to change their rules to permit surplus extraction where there is trustee-employer agreement. This allows trustees to assess the suite of options available in striking a deal with employers on how best scheme members can also benefit – linked to improving member outcomes.” We think this indicates that the Government may legislate to override restrictions in scheme trust deeds and rules that currently prevent surplus refunds, although this is not completely clear.

The notes also contain the reminder that “Trustees have an overarching fiduciary duty to act in the best interests of their members. When considering surplus extraction, trustees must fund the scheme and invest its assets in a way that leads to members receiving their full benefits.”

Details of the Government’s new surplus policy will be set out in its response to the previous Government’s Options for Defined Benefits consultation (see Pensions Bulletin 2024/08). This response is now due this Spring.

The Pensions Regulator has expressed its support for this initiative, but says that its “first priority must be to ensure pension scheme members have the best chance of receiving their promised benefits”.

The Regulator’s statement also includes some fascinating data on funding in the DB universe showing, among other things, estimates that 49% of schemes are now fully funded on a buyout basis and that nearly 9% of schemes are more than 140% funded on a buyout basis. It also shows that the Government’s £160bn relates to surplus when measured on a low dependency basis. This reduces to about £100bn when measured on a buyout basis.

Collecting inheritance tax from unused pension funds and death benefits – consultation closes

There is widespread concern regarding the processes being proposed by the Government so that, from 6 April 2027, it can newly apply and collect inheritance tax from most residual pension savings and from death benefits. This much is clear from responses that have been published in relation to the consultation (see Pensions Bulletin 2024/42) that closed on 22 January 2025.

LCP’s response

In our response we said that there were four key issues:

• The proposed process will delay the payment of all lump sum death benefits, no matter whether any inheritance tax is due, to the detriment of those in need at a time of bereavement. It will also create disproportionate costs and workloads for personal representatives, pension scheme administrators and HMRC.
• The proposed deadlines are unachievable, meaning that there are likely to be a very significant number of amendments, resulting in unnecessary costs and workloads for personal representatives, pension scheme administrators and HMRC, and inappropriate penalties being deducted from benefits to beneficiaries.
• The process requires personal and sensitive data to be shared more widely than necessary, increasing the risk of data breaches and conflict within families.
• It is not clear which benefits are in scope of the new measures, meaning that a whole group who are potentially affected have not engaged with the consultation as they have not realised the measure might affect them.

We then went on to set out how these issues could be addressed, suggesting that a further consultation needs to be completed in the spring to consider a revised approach, before moving on to consultations on draft legislation, guidance and the proposed online tool for allocating the nil-rate band later in 2025.

Other responses

The Pensions and Lifetime Savings Association highlighted unintended consequences for bereaved families, and a severe operational impact on pension schemes in its response. It suggested that the estate should be responsible for paying all inheritance tax, with twelve months from the date of death to settle this before interest accrues, removing the pension scheme as an intermediary. The PLSA went on to say that the Government’s proposed process should be redesigned, placing responsibility for calculation, reporting, and payment squarely with the estate, which has full visibility of the deceased's finances.

The Society of Pension Professionals said that the Government’s proposed method of establishing and collecting inheritance tax from pension schemes was very problematic and that there are better alternatives which it went on to describe.

The Pensions Administration Standards Association called for the proposed approach to be fundamentally changed, saying that it introduced unnecessary complexity and imposed inequitable burdens on scheme administrators and risked poor outcomes for savers and their beneficiaries through increased operational and financial impacts.

The Association of Consulting Actuaries said that radical changes to the proposals will be required if they are to be fair and reasonable in how they apply. Due to there being many practical concerns, a simpler approach is required, recognising that pension assets are fundamentally different from other financial assets. The ACA proposed a separate Pension Inheritance Tax that would help to address concerns regarding financial hardship and timescales.

The Institute and Faculty of Actuaries had concerns that the proposals start to erode the purposes for which governments intended pension schemes to be established – to provide benefits for members upon retirement and protection for their dependants upon death. The IFA said that the proposals as they stand will delay, reduce and complicate benefits payable to dependants – who are financially reliant on the deceased member – in a wide range of situations. The IFoA also said that it shares concerns that the proposals are not workable in practice for pension schemes and other parties, particularly in terms of the timescales and reporting requirements. 

Newsletter 166 announces HMRC action to mitigate the emergency tax issue for those newly drawing down on their DC pot

HMRC’s Pension schemes newsletter 166 published on 22 January 2025 covers eight different topics starting off with a brief mention of the inheritance tax consultation that closed on the same day (see article above). HMRC thanks those who have responded and says that it will publish a formal response and draft legislation later in 2025.

Many of the other matters in the newsletter are little more than a reprise of earlier announcements, reminders of various submission requirements and the latest pension flexibility statistics. But somewhat buried under the innocuous heading of “Tax codes for pensions” is a significant and welcome development in relation to the application of income tax for those new to receiving a private pension.

When a regular income starts to be paid (via a lifetime annuity, scheme pension or income drawdown) or when ad-hoc payments start to be taken (via income drawdown or an uncrystallised funds pension lump sum), the amount of tax deducted will often be incorrect because the scheme normally has to apply a temporary tax rate, often referred to as emergency tax.

This will result in an overpayment of tax for many, especially when a large taxable withdrawal is made. And where this happens, the individual will need to get in touch with HMRC to make a reclaim. Alternatively, they can complete a tax return at the end of the tax year and reclaim through this means.

This overpayment issue is particularly relevant for those who take significant amounts of taxable income from their DC pot as they start their retirement.

HMRC has now announced that from April 2025 it “will automatically update the tax code for customers who are on a temporary tax code and would benefit from being on a cumulative code”. HMRC says that as a result, such individuals should avoid an overpayment (or underpayment) at the end of the tax year.

However, in an addition made shortly after the newsletter was published, HMRC added a line that said “the rules for taxing first pension payments are not changing as part of this and the normal rules of PAYE will continue to apply”.

PPF and FAS – terminal illness eligibility extension

A private member’s Bill that extends the ability of the Pension Protection Fund and Financial Assistance Scheme to make terminal illness payments has been published and is scheduled to have its Second Reading in the House of Commons on 14 March 2025.

The Pensions (Special Rules for End of Life) Bill, introduced by Conservative MP Greg Smith amends the definition of terminal illness in both the PPF and FAS so that people with a life expectancy of up to twelve months (instead of six months) can receive terminal illness payments.

The Bill is almost identical to the private member’s Bill introduced a year ago (see Pensions Bulletin 2024/04), which had assistance from the DWP and which reached the Lords in May 2024 but fell when Parliament was dissolved for the July 2024 General Election.

Government amendments to the Finance Bill published

The Finance Bill that was published on 7 November 2024 following the Autumn Budget, and which is to start Committee Stage in the House of Commons on 28 January 2025, has had a number of Government amendments proposed to it. To accompany these changes, HMRC has published a number of explanatory notes. These show that a number of the amendments relate to easements in the Government’s initial proposed legislation aimed at replacing the non-dom tax regime with a new residence-based system.

None of the Government amendments are directly relevant to pension schemes (other than the removal of references to domicile in provisions of the Income and Corporation Taxes Act 1988 relating to relief on income from investments of two types of overseas pension schemes). No changes are being proposed to the three clauses that impact pension provision (see Pensions Bulletin 2024/44).