Pension Surplus: A Strategic Asset for DB Plan Sponsors

Several impactful ways plan sponsors can utilize pension surplus to help strengthen their organization and support their workforce

Pension Surplus: A Strategic Asset for DB Plan Sponsors

After years of rising interest rates, solid equity growth, and careful plan management, many pension plans are now sitting on a healthy surplus. It’s a great place to be – but it also sparks an important question: how can plan sponsors put that surplus to work?

While the primary goal of any pension plan is to secure the financial future of its participants, one of the most significant opportunities that can arise is the presence of surplus assets. It is more than just a financial buffer—it’s a strategic asset with the potential to drive value for both the organization and its participants.

The Dual Value of Pension Surplus

A well-managed pension surplus can be a win-win for both plan sponsors and participants. While it provides a safety net to absorb market volatility and maintain a strong funded status, it also opens doors to various strategic opportunities that can help provide plan sponsors with valuable flexibility to optimize funding strategies, manage risk, and strengthen the organization’s long-term financial position.

Potential Uses of Potential Surplus

Here are several impactful ways plan sponsors can utilize pension surplus to help strengthen their organization and support their workforce:

Building a Reserve Cushion for Future Benefit Accruals:

For non-frozen plans, a portion of the surplus can be set aside to pre-fund future benefit accruals, helping to ensure long-term sustainability. This could cover several years of expected accruals, providing peace of mind and stability for both the plan and its participants.
Qualified Replacement Plan (QRP):

For terminated plans, plan sponsors may reduce or avoid the excise tax by transferring some or all of the surplus assets to a QRP. A QRP can be a new or existing plan or even multiple plans, including a 401(k) plan, subject to certain restrictions.
Enhancing Participant Benefits:

Surplus assets can be used to fund one-time or ongoing cost-of-living adjustments, increase accruals, or used to implement other participant-focused enhancements.
Adjusting Plan Design:

Some plan sponsors have strategically adjusted their retirement plan structures by reallocating employer 401(k) contributions into their overfunded pension plan. This can enhance corporate cash flow while maintaining strong retirement benefits. High-profile companies like IBM (2023) and Delta Air Lines (2024) have successfully implemented such strategies.
Funding Early Retirement Windows or Severance Packages:

Surplus assets can finance early retirement incentives or severance packages, allowing for smoother transitions during organizational changes. Hewlett Packard successfully executed such a program.
Supporting Additional Employee Benefits (e.g. IRC 401(h) and/or VEBA):

Through a Section 420 transfer, surplus assets can be allocated to fund retiree health and life insurance costs for up to ten years, providing valuable post-employment benefits without straining corporate finances.
Enhancing Executive Benefits:

Surplus can also be utilized to fund Qualified Supplemental Executive Retirement Plans, providing additional security for your key executives.
Improving Funded Status of Merged Plans:

Organizations undergoing mergers or acquisitions can use surplus assets to improve the funded status of less well-funded plans, streamlining administration and reducing operational burdens. Surplus plans may also enhance the attractiveness of a company in M&A transactions.
Boosting Income Statement Performance:

Plans with a surplus position can generate pension income and decrease pension expense, positively impacting your organization’s bottom line.
Increasing Equity Valuations:

Surplus assets should be recognized as non-operating assets, potentially increasing overall equity valuations and improving cash flow.
Returning Cash to the Sponsor:

Upon plan termination, surplus assets can be returned to the sponsor. While subject to corporate, state, and excise taxes, strategies exist to help minimize these tax impacts.

While the potential uses of pension surplus are enticing, it’s crucial to approach these strategies with caution. Before implementing any changes, we recommend consulting with ERISA counsel to ensure compliance with fiduciary responsibilities and regulations. Additionally, plan sponsors should regularly revisit their overall asset allocation and glidepath strategies to help ensure that the use of surplus assets does not compromise the security of plan participants.

Maximizing the Potential of Pension Surplus

Pension surpluses present a unique opportunity for defined benefit plan sponsors to potentially enhance their financial standing while simultaneously benefiting their participants. By strategically leveraging these surplus assets with thoughtful planning and fiduciary diligence, both plan participants and sponsors could potentially reap the benefits of a well-managed pension surplus.

For an in-depth look into the potential uses of surplus and how the glidepath of a plan that features a significant surplus could be structured, download our report: Navigating Surplus: A U-Shaped Glidepath Strategy and Uses of Pension Overfunding

Are you ready to explore how your pension surplus can create greater value for your organization and employees? Contact us to discuss tailored strategies that align with your long-term goals.

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Pension Surplus: A Strategic Asset for DB Plan Sponsors

Several impactful ways plan sponsors can utilize pension surplus to help strengthen their organization and support their workforce