What do defined benefit surpluses and defined contribution small pots have in common? Both are subject to proposed new measures to make them easier to access

The Chancellor and the Prime Minister have both made it very clear recently that they intend to implement a raft of pension reforms, aimed at supporting their policies of consolidation in the industry and UK growth. In our January 2025 issue, we considered the consultation on defined contribution (DC) pensions¹ and now we are going to explore the issues relating to freeing up defined benefit (DB) surpluses in trust-based occupational pension schemes² and automatic consolidation of DC small pots.

• DB surplus release: a step towards greater flexibility, but will it deliver?

On 28 January, at a roundtable discussion with business leaders, Labour leader Sir Keir Starmer and Chancellor Rachel Reeves announced plans for the introduction of "new flexibilities" allowing well-funded DB schemes to release surplus.³ The government has indicated that further details will be published in the spring, with timing that suggests appropriate provisions could be included in the forthcoming Pension Schemes Bill. While the full framework remains to be seen, the announcement raises important questions about the feasibility, governance and economic impact of such a move.

Welcome step, but too late for many?

In principle, allowing employers to share in the upside of their DB schemes is a positive development. Under the current framework, employers bear all of the funding risk with little prospect of benefit in return. This asymmetry has been a key driver towards buy-outs as soon as affordability allows. Many employers, frustrated with the long-term liabilities and lack of flexibility, have simply opted out of DB provision altogether.

Introducing a structured mechanism for surplus release could encourage employers to think differently about their DB schemes, potentially shifting the focus from de-risking to long-term scheme maintenance. However, given the significant buy-out momentum in recent years, the question remains: will this change come too late for a meaningful number of employers? For those that have already de-risked, the opportunity to benefit from surplus release may no longer be relevant.

The role of trustees: will agreement be achievable?

The government has rightly indicated that any surplus release will require trustee approval. Trustees have a fiduciary duty to protect members' benefits and must ensure that scheme funding remains secure over the long term. A surplus at any given moment may not be a reliable indicator of long-term financial health, particularly given market volatility and evolving longevity assumptions.

While there will undoubtedly be cases where trustees feel comfortable agreeing to a surplus release, the threshold for such approval is likely to be high. If the government hopes to make a material impact, additional mechanisms may be needed to give trustees greater confidence. One potential solution could be enhanced Pension Protection Fund (PPF) coverage for schemes that agree to surplus release arrangements. This could help to mitigate trustee concerns by providing a stronger backstop against future funding risks, although if this solution leads to higher PPF levies it may not be a popular move.

Will this deliver the economic boost the government seeks?

A key motivation behind these proposals is the government's broader agenda to unlock pension capital for UK investment. Encouraging DB schemes to run on rather than seek buy-out could, in theory, lead to greater domestic investment. However, there is no guarantee that retained DB schemes will redirect capital towards UK assets and other nations which have previously implemented a similar strategy have done so through financial incentives.

Absent those targeted incentives, trustees will remain bound by their fiduciary obligations to prioritise investment returns and risk management over the government's policy goals. If the government is serious about using DB capital to stimulate UK economic growth, additional measures, such as specific tax incentives or regulatory guidance, may be required to steer investment in the desired direction.

The introduction of flexibilities for DB surplus release marks a notable shift in pension policy thinking. It has the potential to rebalance the risk-reward dynamic for employers and slow the rush to buy-out. However, success will depend on whether trustee concerns can be adequately addressed and whether trustees of schemes that continue to run on are sufficiently incentivised to invest in the UK economy.

• DC small pots

Since the introduction of automatic enrolment, various governments have tussled with the issue of "small pots" (which can arise when individuals change jobs after relatively short periods) in an effort to find a solution to the issues linked to them. These include erosion of value through charges and "lost" pots where individuals simply forget they have these savings or do not know how to trace them. To put the issue into perspective, the 2023 consultation⁴ outcome on small pots detailed the existence of 20 million deferred pots worth less than £10,000, most of which were within auto-enrolment charge-capped default funds, representing an estimated £30 billion in assets. Whilst there has been progress on some points, such as the cap on charges and the work towards the implementation of pensions dashboards, the fundamental concerns of tracing small pots and consolidating them in order to allow for better value for members have continued. The most recent initiative has been the creation of the Small Pots Delivery Group in February 2024.⁵

One of the main focuses in the Pension Schemes Bill will be addressing the challenges posed by DC small pots. The Bill is expected to propose measures that facilitate the consolidation of small pots, reduce administrative burdens and enhance retirement outcomes for millions of savers. In this section, we explore what is currently understood about the Bill's likely provisions concerning DC small pots and their potential impact on the pension landscape.

We have known since the end of 2023 that the preferred approach is likely to be to introduce measures to automatically consolidate small pots of up to £1,000 via the rather grandly named "Multiple Default Consolidator Model" (MDCM). This model aims to streamline the consolidation process by designating multiple authorised pension schemes as "default consolidators" to automatically absorb small pots when individuals leave a workplace pension scheme. Compared to a single consolidator model (where one provider would manage all small pots), the multiple consolidator approach introduces competition and choice, reducing risks associated with monopolisation while still tackling the inefficiencies caused by small pots. However, the government also invited views on the creation of a "pot for life" structure via a lifetime provider, meaning employers would pay contributions to each pension saver's chosen scheme. We therefore still await the legislative detail in the Bill of how any of this is intended to work, although we assume that the proposed contractual override to allow bulk transfers from contracted-based pension arrangements without member consent will play a key part. This will work by small pots meeting certain eligibility criteria, such as being below a certain value threshold (as debated in the 2023 consultation), to be transferred to an authorised consolidator and with the right of opt-out for members. The contractual override will require members to receive clear communication from providers both before and after the transfer.

Members of the pensions industry have expressed concerns about the challenges of the MDCM being created in a timely fashion and working effectively, and have continued to put forward a range of possibilities through 2024. These include suggestions akin to the "pot follows member" proposals in the early 2010s, which would rely on the pensions dashboard infrastructure to allow savings to travel to a new job with the individual until their pot reached a certain size.

So, at the moment, it remains "watch this space" for the publication of the Bill to see exactly how the issue of DC small pots is to be dealt with.

Final thoughts

The proposed measures for DB surplus release and DC small pot consolidation reflect the government's broader strategy of pension reform, aimed at fostering both industry efficiency and economic growth. While surplus release offers a potential shift in the DB landscape, its effectiveness hinges on balancing employer incentives with trustee obligations, as well as addressing whether it can meaningfully support UK investment. Similarly, the aim to address the issue of DC small pots marks progress in tackling fragmentation, but its success will depend on practical implementation and industry cooperation. Ultimately, both initiatives signal a clear push towards greater consolidation and accessibility in the pensions sector, yet their real-world impact will be determined by how effectively they navigate regulatory, economic and operational challenges.

1. Significant DC changes ahead: our insight ↩
2. Trapped surplus and volatile markets: the build-up to the new defined benefit funding regime ↩
3. Pension reforms to go further to unlock billions to drive growth and boost working peoples' pension pots – GOV.UK ↩
4. Ending the proliferation of deferred small pots – GOV.UK ↩
5. Efforts to tackle small pension pots step up a gear – GOV.UK ↩