A deadline is approaching for action to be taken to prevent existing powers in defined benefit schemes to distribute surplus to employers while the scheme is ongoing from lapsing. The deadline for action is 5 April 2016 but three months' notice needs to be given to members and therefore this is an issue that schemes need to start addressing now. In this Pensions Alert we provide further information about this issue and the schemes it applies to and set out action points for employers and trustees to consider.

Details of the issue

Why does this issue arise?

Prior to 6 April 2006 the requirements that occupational pension schemes had to meet for Inland Revenue approval included that if an ongoing scheme had a surplus of more than 5%, steps had to be taken to reduce that surplus. The permitted ways of reducing the surplus included making payments to a scheme employer, and section 37 of the Pensions Act 1995 set out further requirements which applied to those payments.

On 6 April 2006 (A-Day) when the old system of Revenue Approval came to an end, the requirement to take steps to address a surplus of more than 5% was also removed. A new form of section 37 was introduced on 6 April 2006 which reflected this, although it still provided that the making of payments of surplus to employers was subject to specified requirements.

Transitional provisions are included in section 251 of the Pensions Act 2004 so that existing powers which were in place as at 5 April 2006 to pay surplus to employers while the scheme is ongoing can only be retained if a resolution of the trustees is passed and certain conditions are met. The original deadline to pass this resolution was 5 April 2011 but this was subsequently extended to 5 April 2016.

What schemes does this apply to?

In summary the affected schemes are:

  • defined benefit occupational pension schemes to which the old Revenue requirements applied;
  • the rules of which both currently confer and as at 5 April 2006 conferred power on any person to make payments to the employer out of scheme funds; and
  • which are not being wound up.

What powers should the resolution cover?

The affected rules are essentially those giving power to distribute surplus to employers while the scheme is ongoing.

There was initially some uncertainty about whether powers to distribute surplus when the scheme was winding up and other powers to make payments to employers (for example, administration payments) were also affected.

However, in October 2010 the DWP confirmed that this was not the case. The Finance Act 2011 subsequently clarified that the following types of payments are not affected: payments of surplus when the scheme is winding-up; payments made in respect of a member's liability to the employer in respect of crime, fraud or negligence; certain administration payments; and certain authorised employer loans.

What can the resolution specify?

Where the scheme only gives power to make payments to the employer in accordance with the old Revenue requirements to reduce surplus, the resolution will need to set out the circumstances in which the power can be exercised and any conditions attached to it.

However, if the scheme gives power to make payments to the employer otherwise than in accordance with the old Revenue requirements, the resolution can either state that the existing terms of any power will apply, or can specify the circumstances and conditions that will apply.

It is important to note that the resolution sets out the terms on which the affected powers can be exercised in the future. The resolution does not itself amount to an exercise of any power to pay monies to the employer. If the power is retained and falls to be considered at a later point because a surplus arises, it will still be subject to the requirements of section 37 of the Pensions Act 1995 which, for example, currently ensure that any power rests with the trustees and imposes a requirement that the trustees must be satisfied that it is in the interests of the members to make the payment.

What are the requirements for passing the resolution?

The trustees must be satisfied that it is in the interests of the members to make the resolution. For example, trustees may conclude that factors pointing towards this requirement being met include that it could negatively impact on scheme funding negotiations if there is no such power because employers may be concerned about trapped surplus.

A statutory process of giving three months' notice to members and scheme employers must also be followed, and the notice must comply with certain requirements set out in the legislation.

It is only possible to make a resolution once and therefore it is important that the process and the terms of the resolution are correct.

What if a scheme passed a resolution prior to 6 April 2011?

The DWP announced its intention to extend the deadline for passing resolutions to 5 April 2016 in October 2010, and at this point some schemes decided to defer the issue until nearer this date.

However, some schemes may have passed a resolution prior to 6 April 2011. Due to the initial uncertainty about the type of powers which might lapse unless a resolution was passed, some schemes may have passed a broad resolution covering all types of payments to employers including those which it has now been clarified did not actually need to be included. The Finance Act 2011 states that the amendments to clarify the scope of the legislation do not affect the continued operation of any resolution passed before 6 April 2011.

However, the legislation also permits trustees who exercised the resolution-making power prior to 6 April 2011 to exercise the power one further time before 6 April 2016, and allows resolutions made now to amend or revoke a resolution passed before 6 April 2011. This means that trustees could take the opportunity to do this in order to make the scope of the resolution absolutely clear.

In our view, whether a previous resolution should simply be left to stand or whether it should be revoked or amended depends very much on the terms of that resolution. We therefore suggest that employers and trustees in this position seek legal advice.

Action points for employers and trustees

As a first step employers will need to check their rules to see whether there are any powers for surplus to be paid to them that will lapse unless action is taken.

If so, employers will need to engage with the trustees about the passing of a resolution to ensure that the powers do not lapse.

The trustees will then need to consider what the terms of the resolution should be and whether they are satisfied that it would be in the interests of the members to pass the resolution.

If it is decided that a resolution will be passed, the trustees will need to send the appropriate notice to all members and employers before doing so. The notice must meet statutory requirements including that it states the date from which the trustees' proposed exercise of the power is to take effect. It is important to send the notice in good time because the proposed effective date must be at least three months after the date that the notice is sent but also must not be after 5 April 2016. Trustees may want to consider including the notice in another communication, such as a scheme newsletter, that is due to be sent within the relevant timescale.

The resolution will need to be passed by 5 April 2016.

It should also be considered whether the scheme rules will subsequently be amended to make reference to the resolution in order to avoid any confusion arising as to the nature of the powers if somebody were to only look at the rules.

These action points encompass a variety of issues and we would suggest that legal advice is taken in relation to these steps to ensure that any resolution is effective.