What pension 'megafund' changes announced by Rachel Reeves could mean for you
The chancellor wants to unlock billions of pounds of investment in business and infrastructure with what she says is the "biggest pension reform in decades".
Chancellor Rachel Reeves will lead a shake-up of the pensions market that the government hopes will unlock tens of billions of pounds of investment in business and infrastructure.
In her Mansion House speech on Thursday, Reeves was expected to outline plans to merge council pension schemes into "megafunds" in what she describes as the "biggest pension reform in decades".
It will see the UK’s 86 council pension schemes pool their collective assets into a small number of 'pension megafunds'. Reeves hopes this will lead to £80 billion being invested in energy infrastructure, public services and tech start-ups.
Reeves has said that public sector pension funds are not currently big enough to generate good returns - but some have warned there are risks attached to her approach.
Yahoo News breaks down what it means and the potential benefits and risks involved.
How will it work?
Around 6.7 million local government workers currently have a pension that is based on their length of service and salary - what is known as a defined benefit pension. This is in contrast to private sector schemes that involve paying into a savings pot each month.
The payments these workers make will not change.
Instead, the government will set a minimum size requirement for the defined contributions schemes.
Larger funds will, in theory, generate greater returns and be more efficient to run.
Helen Morrissey, head of retirement analysis at Hargreaves Lansdown, explains: “These reforms are intended to improve retirement outcomes for people while boosting UK economic growth.
What could the benefits be for pension-holders?
Larger pension funds will lead to lower costs and better returns for members because, in theory at least, they will "operate more efficiently", Morrissey explains.
At present, the UK's pension fund market is "fragmented". That means running each scheme costs money in terms of administration, governance and management costs.
Larger funds will not only have the scale to potentially invest in larger projects with better returns - they will also have investment experts and bargaining power to drive down fees, saving money.
Fiona Peake, an Ocean Savings pensions expert with over 10 years of experience, says: "This approach could offer pension holders several benefits. With greater investment clout, these megafunds could access high-growth areas - like infrastructure and tech - that smaller funds might struggle to enter. In the long run, that could mean higher returns, which ultimately benefit savers."
What are the potential risks?
There are risks attached to the 'megafund' approach, experts have told Yahoo News, with some warning that a focus on economic growth might encourage risky investments.
Peake told Yahoo News: "Consolidating pensions into massive funds concentrates investment decisions and could leave pension holders more exposed if these funds don't perform well. While the goal is stability, the scale of these investments means any significant downturn could have a widespread impact on pension values."
Another risk is whether there are enough big UK projects for investors, says Morrissey.
Morrissey says: "There are of course risks - there needs to be a sufficient pipeline of high quality projects to be invested in. Otherwise there are concerns that pensions may take more risk which could impact returns."
Sir Steve Webb, a former Liberal Democrat pensions minister, cautioned that "big isn't always beautiful", adding: "There are some smaller pension schemes in Britain which are very good.
"They are heavily subsidised by employers, they offer very good pensions and it would be very unfortunate if something like that was destroyed by a crude size rule."
Another potential risk could be that megafunds end up being “pretty much the same”, he said, adding: "When there are a lot to choose from, there's quite a bit of competition."
How could it affect your current pension?
The new megafunds could mean savers see investments shifted into new areas, Peake says.
Peake says that fees might come down due to economies of scale, which would be "a win for savers". She adds that some savers might feel uncomfortable with a less personalised approach, as individual fund choices could become more limited.
At present, however, pension holders don't need to do anything, says Peake.
"These changes are still in proposal stages," she says. "If this policy goes ahead, it will likely be several years before any noticeable impact, so it's worth monitoring for updates rather than making immediate decisions."
How does it work in Australia and Canada?
In Australia and Canada, 'megafunds' are already used successfully, with pensions of government workers pooled into large funds which invest round the world.
Rachel Reeves has described them as "probably the best pension funds anywhere in the world".
But these pensions are not without problems: Ontario Municipal Employees Retirement System is the largest investor in the troubled water firm Thames Water.
"This model has seen success in countries like Canada and Australia, where large pooled funds have delivered steady returns," says Peake.
"Yet the UK has its own set of market dynamics, and it's hard to say if success abroad will translate seamlessly here. For now, it's about balancing ambition with careful consideration to protect savers' interests in the long term."
Jon Greer, head of retirement policy at wealth manager Quilter, said: "While Canada has very large pension schemes, they too are looking for ways to increase domestic investment. Currently, roughly 7% of Canadian scheme infrastructure investment is domestic. This highlights the challenge of finding suitable domestic projects even for large funds."
