Understanding the Surplus

A pension surplus occurs when the fair value of plan assets exceeds projected benefit obligations. Surpluses often result from strong investment performance, conservative funding strategies or plan design changes such as freezing accruals. While a surplus reflects prudent management, it is not a blank check. ERISA and IRS rules impose strict limitations on how surplus assets can be used, and employers must weigh financial, fiduciary and reputational factors before acting.

Leaving a surplus untouched may seem safe, but it can have unintended consequences. Excess assets represent an opportunity cost if they could otherwise reduce corporate expenses or enhance employee benefits. Market volatility can quickly erode a surplus, turning it into a deficit. And even overfunded plans may incur Pension Benefit Guaranty Corporate (PBGC) premiums, adding unnecessary cost. Strategic surplus utilization helps sponsors optimize balance sheet efficiency, improve workforce benefits and mitigate future risks.  

Permissible Uses of Pension Surplus

Regulatory frameworks allow several options for surplus deployment, each with unique implications:

	Contribution Holidays Employers may reduce or suspend future contributions if the plan remains above funding thresholds. This approach improves short-term cash flow but requires careful monitoring to avoid underfunding during market volatility.
	Benefit Enhancements Plans can use surplus assets to improve participant benefits — such as cost-of-living adjustments or early retirement incentives—subject to nondiscrimination rules. This option can strengthen employee relations and support workforce transitions.
	Pension Risk Transfer Surplus assets can fund annuity purchases or lump-sum windows, reducing long-term liabilities and administrative burden. While this may involve upfront costs, it stabilizes the sponsor’s financial exposure.
	Reversion to Employer Under strict IRS guidelines, employers may reclaim surplus assets upon plan termination, typically subject to a 50% excise tax plus income tax. This option is rare and often viewed unfavorably by stakeholders, but it remains a legal pathway.
	Transfer to Retiree Health Plans Section 420 of the Internal Revenue Code permits surplus transfers to fund retiree medical benefits, provided certain conditions are met. This strategy can offset rising healthcare costs while benefiting retirees.

Key Considerations & Strategic Opportunity

Surplus utilization is not purely a financial decision. Employers must ensure compliance with ERISA, IRS and PBGC rules, and consider how actions will be perceived by employees, unions and regulators. Decisions should not compromise long-term funding security, and economic outlook matters as interest rate trends and market volatility can quickly alter funded status projections. A robust governance process that includes actuarial analysis, legal review and clear communication planning is essential to avoid missteps.

For employers, a surplus represents a rare chance to strengthen financial flexibility and enhance workforce benefits. Whether through contribution relief, risk transfer or retiree health funding, thoughtful surplus management can deliver measurable value. 

However, the complexity of rules and potential reputational risks demand a disciplined approach.

Compliance Checklist

	ERISA funding rules: Ensure plan remains above minimum funding thresholds post-action.
	IRS regulations: Validate tax implications for contribution holidays, benefit enhancements or reversions.
	PBGC premium impact: Assess whether surplus actions affect variable-rate premiums.
	Section 420 requirements: Confirm eligibility for retiree health transfers and compliance with notice provisions.
	Nondiscrimination testing: Verify benefit enhancements meet regulatory standards.
	Plan termination rules: Understand excise tax and income tax obligations for employer reversions.
	Governance documentation: Maintain board approvals, actuarial certifications and participant communications.