Pension Surplus: A Wealth of Opportunities

Historically High Funded Status Drives a Shifting Focus

Many U.S. corporate DB plans have been overfunded for more than four years. Of the 100 largest plans at the end of 2025, 61 were overfunded and 20 were at least 120% funded vs. 45 and 12, respectively, three years ago.² Thanks to strong equity market returns and rising discount rates in the first nine months of 2026, even more plans are likely overfunded today.

Against this backdrop and given extensive DB de-risking and regulatory relief over the last 5 to 10 years, surplus management is becoming a key topic for DB plan sponsors. While PRT and plan termination may still be the ultimate goal for some, a “wait-and-see” approach gives plan sponsors time to evaluate surplus capitalization options without irrevocably shrinking the plan. In the meantime, the surplus can contribute to pension income in the financial statements and offset administrative expenses, adverse plan experience, and assumption changes.

In this paper, we briefly illustrate how stronger funded status and robust hedging have reduced pension risk and touch on the costs of plan termination. We then discuss how the surplus can be actively used to address a range of corporate objectives and conclude by offering a sketch of a hypothetical retirement program redesign with the potential to benefit both plan participants and plan sponsors.

Better Funding & Better Hedging Mean Lower Risk

One of the main reasons plan sponsors seek to terminate a DB plan is the complete elimination of pension risk. En route, plan sponsors may execute large-scale PRTs to shrink the plan and, therefore, its risk to the plan sponsor. 

Yet an overfunded, appropriately de-risked, frozen plan is unlikely to become underfunded. Even if underfunding occurred, the resulting deficit and cash contributions would likely be relatively small for three reasons:

• The alignment of assets to liabilities materially reduces the impact of a downturn in the capital markets on funded status.
• The surplus serves as a cushion and reduces the risk of falling below 100% funded and triggering cash contributions.
• Even if a plan's funded status falls below 100%, the American Rescue Plan Act of 2021 (ARPA) has significantly lowered the required cash contributions, in many cases by roughly 50% compared to pre-ARPA requirements.

Additionally, PBGC³ variable-rate premiums have been fixed at 5.2% of unfunded vested benefits since 2024 (instead of being indexed to inflation), further reducing the cost of underfunding.

A frozen plan that is at least 100% funded can often generate sufficient returns to offset the interest cost of the liabilities, ongoing administrative expenses (including PBGC fixed rate premiums which continue to be indexed to inflation), and adverse plan experience, making the plan largely self sustaining. Materially overfunded plans are likely to keep growing their surpluses, especially as they may allow for riskier asset allocations. That said, PRT can be financially advantageous in certain situations, such as participant groups with small benefits (though many plan sponsors have already taken advantage of these PRT opportunities). We illustrate these effects in the example below.

Termination May Not Be the Answer

Plan sponsors can directly access the surplus only upon plan termination. Even then, any surplus that reverts to the plan sponsor is subject to corporate income and excise taxes—up to 71% combined—unless the entirety of the surplus is used to increase benefits for existing plan participants or set up a qualified replacement plan.

Settlement accounting, which is required upon plan termination or large PRTs, can make termination unattractive for plans with large unrecognized pension losses because it creates a material one-time hit to income in the financial statements.

Other termination hurdles include data cleanup, participant communication, annuity search, actuarial, legal, and potentially independent fiduciary services. These can be substantial for complex plans with disparate participant groups and benefit formulas.

Still, as Kodak illustrated in 2025, termination with (partial) reversion may suit a cash-strapped plan sponsor that is not subject to income tax—though still subject to excise tax—and that can use the reverted assets to efficiently address a challenged balance sheet.⁴

Illustrative Example

We consider a hypothetical frozen plan that has a liability (projected benefit obligation) of $1 billion, a duration of 10.1 years, a discount rate of 6.45%, and an administrative expense load of 0.5%, as of September 30, 2026.⁵ The hurdle rate to maintain its funded status is 7.0% if the plan is 100% funded and 6.3% if it is 110% funded.

The asset allocations shown in Figure 1 are illustrative. A plan that is 110% funded with an 85%/15% liability-hedging/return seeking asset allocation is expected to grow its surplus as its return exceeds the hurdle rate by 0.7% (after rounding). Under a sample market stress scenario with an instantaneous 40% drop in global equities, a 2% decline in Treasury yields, and a 1% widening in AA credit spreads, the funded status does fall, but only to 104%.

As funded status improves, risk moderately increases, which raises both the return over the hurdle rate and funded status volatility. Even in the sample market stress scenario, if the plan starts at 110% funded or better, it is expected to remain overfunded and require no cash contributions.

Please see the Appendix for the actuarial and investment return assumptions used in this example.

A Surplus Creates Immediate Opportunities

Under circumstances where plan termination is unattractive and pension risk and expense are deemed manageable, hibernation—potentially with re-risking as the surplus increases (similar to Figure 1)—may be appropriate. This approach gives plan sponsors flexibility to draw on the surplus indirectly, either on an ongoing basis or in one-off situations, avoiding corporate cash outlays.

Permitted ongoing uses include funding benefit accruals (if applicable) and retiree medical benefits (up to 1.75% of assets per year, provided the plan remains at least 110% funded). In the illustrative example above, the hypothetical frozen plan that is 110% funded could budget up to 0.7% of assets, its excess over the hurdle rate, for these purposes and still maintain 110% funded status (assuming all actuarial and investment return assumptions are realized). Notably, at 140% funded, even an open plan may be able to sustain a service cost of as much as 2.2% of assets, or 3.1% of liabilities, and still remain well-funded, even in a moderate stress scenario.

A surplus can also fund workforce management initiatives, such as enhanced early or late retirement benefits and collective bargaining commitments. For example, in July 2026, PECO, an electric utility in Pennsylvania, agreed to offer newly hired union employees a pension benefit following a three-day strike.⁶

Further, a surplus could help in a future M&A transaction involving an underfunded plan. Merging overfunded and underfunded plans would reduce (or eliminate) the underfunded plan’s deficit and the associated cash contributions and could reduce PBGC variable-rate premiums.

Finally, plan sponsors may wish to wait to see whether Congress takes up the Strengthening Benefit Plans Act of 2025, which would allow employers to fund DC plan contributions directly from the DB surplus, without first terminating the DB plan and provided the DB plan remains at least 110% funded. The bill has stalled since its introduction, but its potential positive impact on federal government revenue could help its prospects in future budget negotiations.⁷

A Bigger Possibility: Retirement Program Redesign

Surpluses exceeding 20% of plan assets may offer an interesting opportunity to restructure the retirement program more broadly, in some ways similar to what IBM did in 2024.⁸ This type of restructuring can potentially improve participant outcomes and lower plan sponsor cash outlays, without materially increasing funding risk.

A potential redesign could consist of:

• Re-opening an overfunded DB plan under a cash balance (CB) design with a conservative or market-return interest crediting rate (ICR), such as those in Figure 2.
• Shifting part or all of the current employer DC contribution to the CB service credit and fund it from the DB plan surplus, rather than corporate cash.
• Adjusting the DB plan investment strategy such that:
  • Legacy liabilities and any new retiree annuity liabilities are supported by assets in a traditional liability-driven investment strategy; and
  • Accruing CB liabilities are supported by the remaining assets invested to match the CB ICR.
•  Increasing risk in the DC plan’s target date suite (or other QDIA⁹) if the CB ICR is conservative, so that the target combined DB plus DC benefit at retirement is similar to the current DC-only benefit.

Effectively, the DB plan serves as a conservative (or moderate) “floor” benefit with an annuity option, while the DC plan serves as a higher-risk supplementary lump-sum benefit, similar to how 401(k) plans were originally conceived.

Notably, this approach could result in lower plan sponsor costs and risk than DB plans from 10 or 20 years ago: contributions are funded from an existing surplus and investment risk can be greatly reduced (or even eliminated) by the choice of ICR. Specifically, the design avoids ICRs that are hard to hedge: fixed-rate, bond-based, and those with floors and ceilings. Longevity and demographic risks remain but could be mitigated because a lump sum is the normal form of benefit in a CB design. Depending on its size relative to the service credit, a surplus could last decades.¹⁰

A restructuring plan like the one sketched above has many nuances, including the CB Preservation of Capital Rule that could be meaningful for more aggressive ICRs, different actuarial treatments of market-return CB liabilities under ERISA funding requirements and U.S. accounting standards, demographic considerations, and participant communications.¹¹ Figure 3 summarizes some key benefits and risks of this design vs. a standalone DC plan for both a new participant (with no legacy DB benefit) and the plan sponsor.

Design variations—such as a variable annuity formula rather than a CB formula or a one-time DC-to-DB transfer option—may be worth the added complexity for some plan sponsors. The right approach depends on corporate objectives, the size of the surplus, employee demographics, and other factors warranting input from actuarial, legal, and investment advisors to develop a plan tailored to a plan's specific circumstances.

In Closing

DB plan surpluses create actionable flexibility for plan sponsors and may make large-scale PRT and termination less attractive. A well-funded, de-risked frozen plan may be largely self-sustaining, allowing sponsors to put the surplus to work funding residual benefit accruals, retiree medical benefits, workforce initiatives, or an underfunded plan acquired in an M&A transaction. A more consequential decision is whether to rethink the retirement program more broadly by potentially re-opening the DB plan in an attempt to improve participant retirement outcomes and lower aggregate employer cash outlays without materially increasing employer risk. Whatever path is chosen, a pension surplus can be a valuable corporate asset.

As always, we welcome the opportunity to speak with you or your advisor about how Dodge & Cox investment solutions could support your pension investment and risk management efforts as you progress along your pension journey.

Appendix: Hypothetical Frozen Plan Analysis

Plan characteristics: Present value of liabilities: $1 billion, duration: 10.1 years, convexity: 1.8. Discount rate: 6.45%, FTSE Above Median AA, as of September 30, 2026. Credit beta of investment-grade credit to the liability discount rate: 1.3. For purposes of funded status risk (i.e., the volatility of funded status), liabilities are represented as the following blend of market indices: 60% Bloomberg U.S. Long Credit Index, 17% Bloomberg U.S. Intermediate Credit Index, 15% Bloomberg Long Treasury Index, 8% Bloomberg Intermediate Treasury Index. This blend of indices was selected to match liability duration and credit beta.

Hurdle rate assuming 6.45% discount rate and $5M load for administrative expenses: ($65M + $5M)/($1,000M) = 7.0% at 100% funded status and ($65M + $5M)/($1,100M) = 6.3% at 110% funded status. Values reflect rounding.

Hypothetical portfolios: Liability-hedging assets consist of Long Credit, Intermediate Credit, and a Treasury completion portfolio represented, respectively, by the Bloomberg U.S. Long Credit Index, the Bloomberg U.S. Intermediate Credit Index, and a blend of the Bloomberg Long Treasury Index, the Bloomberg Intermediate Treasury Index, and the Bloomberg 3-Month T-Bill Index, that achieve the target interest rate and credit spread hedge ratios. Index fixed income characteristics are calculated using PORT+. Return-seeking assets consist of global equities as represented by the MSCI ACWI Index.

Stress test: Stress test assumes an instantaneous return of -40% for the return-seeking assets, a 2% decrease in Treasury yields across all maturities, and a 1% increase in AA credit spreads across all maturities. Asset and liability returns are calculated based on these assumptions and index and liability durations, convexities, and credit beta, respectively.

Capital market assumptions: These assumptions are hypothetical and provided for illustrative purposes only. Actual returns may be materially different from those shown. While we believe these assumptions to be reasonable, other assumptions may be reasonable and may lead to results that differ significantly from those derived using these assumptions. Some assumptions have been made for modeling purposes and are unlikely to be realized; not all assumptions have been stated or fully considered; and changes in assumptions may have a material impact on the hypothetical results presented. No investment strategy or risk management technique can guarantee returns or eliminate risk in any market environment. These assumptions do not represent actuarial, accounting, or legal advice.

Fees: Assumptions are for broad market indices. You cannot invest directly in an index; actual investments will be subject to investment management fees and other investment-related expenses.

Market indices: Indices used in the development of the assumptions are as follows: Bloomberg 3-Month T-Bill Index, Bloomberg U.S. Long Credit Index, Bloomberg U.S. Intermediate Credit Index, Bloomberg Long Treasury Index, Bloomberg Intermediate Treasury Index, and MSCI ACWI Index net of international dividend taxes when available, and gross otherwise.

Equity expected returns: Returns for equities reflect Dodge & Cox model expectations for dividend yield, EPS growth, and change in valuations (P/E ratios) for the relevant market indices over a 10-year time horizon, as of September 30, 2026.

Cash and fixed income expected returns: Compound returns for cash and fixed income reflect the yield and roll-down on the respective market indices as of September 30, 2026.

Standard deviations and correlations: Standard deviations and correlations reflect monthly observations for the 10-year period ending September 30, 2026; standard deviations are annualized.

Funded status risk accounts only for the investment component of funded status risk and does not reflect any potential alpha in excess of index returns, potential tracking error to the index, or deduction of any investment management fees.