Rachel Reeves in radical pension shake-up to boost growth

Chancellor Rachel Reeves is planning what she calls the "biggest pension reform in decades" in an attempt to boost economic growth.

The government wants to merge the UK's 86 council pension schemes into a handful of "pension megafunds".

It is hoped the changes will lead to billions of pounds being invested in the UK in areas such as energy infrastructure, tech start-ups and public services.

Reeves told the BBC that UK public sector pension funds in their current form were not big enough to generate good returns for British savers, but some argue the changes are not without risk.

Workers in local government schemes have a pension based on salary and service length - known as a defined benefit pension - and they will not see any change to their payments as a result of the plans.

Most private sector workers are in schemes where they pay into a savings pot each month, and their eventual pension depends upon the size of this when they retire.

The government is considering setting a minimum size requirement for these defined contributions schemes. It is hoped that larger funds will be more efficient to run and generate greater returns, which could mean people's pension savings grow faster.

Reeves told the BBC ahead of her first speech as chancellor at the annual Mansion House gathering of investors in London that she wants the UK's pension schemes to be more like Canada and Australia.

In those countries, pensions of local government workers, such as teachers and civil servants, are pooled into a handful of funds which are able to make big investments around the world.

"They probably have the best pension funds anywhere in the world," Reeves said.

The pension reforms are part of Reeves' plan to boost growth and come after many businesses have criticised the rise in employer National Insurance contributions in the Budget.

She told the BBC that she is "not immune to those criticisms, but it was necessary to increase taxes” to get the state finances in shape and “properly fund” public services.

The government plans to merge the 86 council pension funds - which include £354bn in investments and are run by local government officials - into "megafunds" run by fund managers.

The Prime Minister’s spokesperson has acknowledged that new pension “mega funds” will not be obliged to invest in UK businesses or infrastructure.

“This isn’t looking at mandating of investment, this is about bringing forward the reforms necessary to create scale in our pension funds.”

The government also wants to set a minimum size limit on defined contribution schemes in the private sector, which manage around £800bn of investments, to encourage the consolidation of the around 60 different multi-employer schemes.

The government says its changes could "unlock" £80bn worth of investment into the UK.

"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 said.

Iain McGill, chief executive of UK biotech firm Quell Therapeutics, told the BBC the proposed changes could help firms like his.

He says there comes a point when access to "significant" funds is needed for biotech companies to expand.

At the moment most of those funds are in the US, "and if we don’t have access to it in the UK that’s when a lot of companies decide to relocate to the US".

The UK's pension fund market is "incredibly fragmented", according to Helen Morrissey, pensions expert at Hargreaves Landsdown.

Running these schemes costs money. Each one must pay administration, governance and management costs.

If larger funds are created by combining smaller ones, Ms Morrissey says, they will have the scale to invest in larger projects.

They also have greater bargaining power to drive down fees, which should increase investment returns, and could have the ability to hire their own investment experts.

Tracy Blackwell, chief executive of Pension Insurance Corporation, told the BBC: "I think by having the scale and the right expertise internally to invest in a wide range of assets, they'll be able to invest in a lot more than what they can invest in now."

On Wednesday, Canadian pension fund, the Public Sector Pension Investment Board, bought the company that owns Aberdeen, Glasgow and Southampton airports in a deal worth more than £1.5bn.

However, big investments can also bring bigger risks, with Canadian pension fund the Ontario Municipal Employees Retirement System being the largest investor in troubled Thames Water.

Gervais Williams, head of equities at Premier Miton, said combining smaller schemes into megafunds was a "mistake".

"They've always been able to invest in big companies, but also small companies. These megafunds, by implication, they'll invest in mega companies and many of the smaller companies will be, unfortunately, less significant in them going forward.”

Some have argued the changes could bring risks for pension savers.

"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 investment platform AJ Bell.

He said the current system encourages trustees to deliver the best outcome for members rather than focus on UK-wide economic growth, which might mean investing outside the UK.

Others question whether there are enough big UK projects to invest in.

"Large funds need substantial, reliable projects to generate returns, but the market may struggle to offer enough of these opportunities, especially in the infrastructure sector," said Jon Greer, head of retirement policy at wealth manager Quilter.

Shadow chancellor Mel Stride said the Conservatives "will be looking closely at the detail of what Rachel Reeves sets out – particularly regarding the mandating of where investments are to be made".

Former chancellor Jeremy Hunt said there was "much to welcome" in Reeves' plans, adding it was broadly the "same strategy and approach" he had announced in his Mansion House reforms last year.