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There’s gold in them pension pots (possibly)

The glory days of final salary pension scheme surpluses are long gone. But in these days of austerity and cost-cutting measures, it is still possible to find surplus locked away inside the arrangements that many employers have set up in their place – the defined contribution occupational pension scheme.

In such schemes, the benefits payable will depend on:

  • contributions paid in respect of the member;
  • investment return achieved on those contributions; and
  • rate of exchange in converting an individual retirement account into an annuity from an insurance company (or, in some cases, a pension from the scheme itself).

There are often funds that are not allocated to members' individual retirement accounts - so they can be used for other purposes.

How could a DC scheme generate a surplus?

Trustees of defined contribution schemes are generally required to maintain a 'reserve account'. This account will generally be used to meet the administrative expenses of running the scheme (such as investment charges or insurance premiums) or, in some cases, to fund benefits payable on the death or ill-health of a member. Over time, there is potential for 'surplus' to build up in the reserve account because:

some members leave employment or opt out of the pension scheme before they have completed at least three months' pensionable service - when the statutory requirement to refund member pension contributions kicks in - so the money will be left in the reserve account;

the requirement to refund contributions only relates to the contributions made by the member. It does not apply to contributions made by the employer - and bear in mind that any contributions made under a salary sacrifice arrangement will be deemed to be employer contributions for this purpose (ie non-refundable);

if the employer provides life assurance or incapacity benefits for members via the DC scheme, they often make 'administrative' contributions to the reserve account to fund the benefits in advance - but the cost of insurance premiums or the number of ill-health cases could turn out lower than expected.

A combination of the above factors could result in significant unused funds accumulating in the reserve account - in some cases, potentially totalling thousands of pounds.

At a time when cash-strapped employers are looking to economise and save on employment costs, it is a shame that these pots of money often sit around unused. The trustees of the pension scheme also have a responsibility to take specialist advice and make decisions about investing the reserve account assets - which in itself costs money, and only compounds the problem.

It is worth checking your scheme rules in case the employer has a say in how the reserve account should be spent. For example, an employer may wish to use surplus funds to pay the employer's scheme contributions for a period of time - in effect, giving it the benefit of a contribution holiday - or other administrative expenses. This can be a major relief when HR budgets are already stretched to their limits. Sometimes trustee consent is required, at other times not - each scheme will have its own rules on the point. Your legal advisers can help you on this.

The ability to make use of surplus in the reserve account only applies to occupational pension schemes - it does not apply to personal pension schemes run by third party providers, such as an insurance company. But if you have an occupational pension scheme, it is worth checking how much is in the balance and how it can be spent - there may be hidden gold there after all!

Nigel Cayless, Solicitor at specialist pensions law firm Sacker and Partners