Government plans to create pension mega funds: what it means for you

The pension fund overhaul could mean more generous returns, but critics warn it could also put savers' funds at risk.

Rachel Reeves is planning the biggest shake-up of the pension sector for decades. 

In a speech at the City’s Mansion House, the Labour Chancellor said she intends to merge 86 public sector council pensions into so-called ‘mega-funds’ which will be run by fund managers.

This is to ape the Australian and Canadian systems where similar pension funds are large enough to invest in new industries and major road and rail infrastructure projects.

Britain’s public sector pension schemes are worth around £500 billion.  

What is Reeves planning?

Reeves says existing UK public sector pension funds aren’t big enough to make sufficient returns for pension savers and that pooling the money together in larger funds will provide economies of scale. 

"Our pension funds in Britain are too small to be making the investments that get a good return for people saving for retirement and to help our economy to grow," Reeves told BBC News.

The Chancellor says she wants to use the funds to kick-start the UK economy instead of having them tied up in investments such as government bonds.  

What could be the advantages?

Labour claims the changes could "unlock" £80 billion of investment in the UK.

Under the new regime, local authority pension schemes will also have to invest a minimum of 5% of their funds in the local economy. 

The changes will not, however, affect how Defined Benefit – final salary pension schemes – pay out. 

In theory, it could also mean unlocking potentially more lucrative revenue streams for pension savers as funds are able to target bigger investment opportunities here and abroad. 

What are the potential pitfalls?

Proposed changes to private pension funds – or Defined Contribution schemes – could affect how pension savings grow. It could also see pension funds merge. 

The Government is also planning to bring in a minimum size for private pension funds.

The sector is currently worth £800 billion. 

Critics say pension savings could be at risk, however.

"Conflating a government goal of driving investment in the UK and people’s retirement outcomes brings a danger because the risks are all taken with members’ money," said Tom Selby at stockbroker AJ Bell.

Selby said the current system incentivises pension trustees to prioritise the best outcome for members, but that this might not necessarily dovetail with the aim of pursuing UK economic growth. 

Less choice for pension savers?

Meanwhile, the Society of Pension Professionals (SPP) President Sophia Singleton warned that the changes could mean small but well-performing pension funds are forced to close and that savers have less choice over where to invest their pension money.

“There are clear benefits from having larger pension schemes - operational and cost efficiencies and from an investment perspective it may increase access to illiquid opportunities such as infrastructure investments,” she said. 

“However, there are risks too. For example, having too few schemes can stifle innovation, lead to a herding mentality and remove choice for both employers and savers. 

“This could also lead to the closure of some very good but smaller pension schemes, which may not be in the best interests of savers.”