Employers are not only keeping defined contribution members in trusts with a defined benefit surplus to save money on contributions; they are also moving them back into these where they were previously in other arrangements, experts have said.  

  

The recent rise in DB funding levels have led to considerable surpluses for some schemes. More sponsoring employers are looking to use part of the surplus to fund their ongoing contributions for DC members in hybrid pension trusts.  

  

Some have also put a planned move of DC members to a master trust on ice with a view to saving on contribution costs, while others are even bringing DC members back into a hybrid trust.  

 

  

Firms consider this option where there is a sizeable surplus, said Jonathan Sharp, a partner at law firm Baker McKenzie. It is a way the employer can use the surplus without moving it back onto the company’s own balance sheet, which would incur a 35% tax charge.  

  

Sharp said one aspect for employers to consider is the type of arrangement that DC members are currently in. If they are in a trust-based DC scheme, the members can usually be moved across including past benefits, while a bulk transfer of past benefits is not possible from a group personal pension. However, employees can still be moved across for future service and could decide to transfer their past service benefits themselves. A similar route can be chosen if an employer wanted to move employees back from a DC master trust.  

  

This can be done without incurring too much cost, although there is the ongoing cost of administering the DC pensions, but he says: “The settled cost [of a transfer] wouldn’t be too high.” 

   

While employers might be keen, trustees would among others want to be happy that the use of surplus for DC members does not impact negatively on the DB members in the scheme. They would therefore need to be clear which assets can be used and which can’t. 

 

Sharp says typically surplus that can be used for DC contributions would be the surplus that is in the scheme beyond full buyout funding plus a buffer, in case buyout prices move.  

 

 

Companies thinking about moving DC members into a hybrid scheme should not underestimate the project management required, as there are “a number of moving parts”, he says, from legal documentation for the new DC section and sorting out the DC administration, to HR and communication.   

  

“It can take at least six months. It’s not a quick thing,” he said. 

  

The member population must be informed and due process followed for such a big change. Sharp recommends that before undertaking a transfer, there should be a 60-day consultation with members, “because you are stopping contributions to one scheme and starting them to another”.   

 

Trustees and employers might even want to think about rebranding the hybrid scheme to ensure it resonates with the current scheme population.    

  

Even if all these aspects are considered, employers have to be comfortable with making this change under the current legal framework, because there is a wrinkle in the legislation. Under the auto-enrolment requirement, the law refers to contributions having to be made by the employer. 

  

“Where it’s a surplus it’s not strictly a contribution from the company to the member because the money is already there,” notes Sharp. Therefore, as trustees and employers, “you need to be satisfied around that point”.  

  

A government call for evidence around ‘Options for DB schemes’ issued in July is exploring whether DB schemes and employers should be incentivised to create surplus. Apparently unaware that this practice already exists, the Department for Work and Pensions asks if it would be appropriate for sponsors to use DB surplus for DC members.   

  

However, it says that surplus would be used for “additional contributions over and above statutory minimum contributions for auto-enrolment for DC members”, potentially implying that the auto-enrolment legislation’s reference to employer payments should be interpreted narrowly.  

 

 

Despite the language in the legislation and uncertainty over the level of pragmatism the Pensions Regulator would apply, employers are increasingly looking at this option. Moving DC members into hybrid trusts is starting to be discussed, says Helen Ball, partner at law firm Sackers.  

  

“It is easy to see why this is an attractive idea,” she adds. “It might not work for everyone though, and it will require some preparatory work to be done in each case to see if this is a realistic proposition for any given employer or scheme.”  

  

For example, employers would need to check that the receiving scheme’s trust deed and rules give the power to use any surplus for DC section contributions in the first place.   

  

“If not, they will be very disappointed further down the line if they won’t be able to use the surplus to achieve their objective,” she says. Employers also have to make sure that they have the power to transfer the assets out of their existing pension arrangement into the receiving scheme.  

  

As the assets would come out of a separate occupational DC scheme, it would mean the employer liaising with the trustees of that scheme, who will have their own legal duties to comply with. 

   

In turn, “the trustees of the receiving scheme would also have quite a few things to think about”, says Ball, mainly if they have the power in their scheme’s deed and rules to receive a bulk transfer in and make sure the transfer is a 'recognised transfer’ for tax purposes.  

  

In cases where this power is discretionary, they would also have to consider if they are right to exercise it. This means “looking at any potential impact on existing scheme members, which may not be straightforward”, she notes.  

   

 

Mark Futcher, a DC partner at consultancy Barnett Waddingham, has not quite seen employers moving DC members back into hybrid trusts, but says: “I have seen people thinking about moving to a master trust stop that dead and keep the structure, so they can use surplus to pay running costs.”  

 

He adds that this is “happening quite a lot at the moment”. 

 

Typically, the DC members are kept in the hybrid trust as an overfunded DB section is being bought out, leaving behind a surplus, he says. 

 

Not all will be equally keen to go down the route of running their own DC scheme, however. Some employers and trustees will be concerned about the risk of ongoing governance, he notes, as the requirements are continuously being increased, in part to force schemes to consolidate. 

 

“The challenge is [that] own-trust schemes will have to prove they are offering equally good value as some of the alternative options. They will struggle [to do that] if they don’t have scale themselves,” he notes. 

 

However, he says this can be offset to a degree by using a bundled arrangement. Futcher says he is seeing a rise of bundled own-trusts looking to mirror products and features that members receive from master trusts. 

 

“They would align the own-trust proposition in terms of default and admin to the master trust, so they can sweep out deferred and retired members” into the master trust. “Then the trustees are just left with active employees effectively.”