UK Pensions Briefing | Pensions for growth: The government’s ambitious proposals

Introduction

Growth, says Rachel Reeves, is her “number one mission”. UK pension schemes, with vast assets, have since come sharply into political focus. Here, we focus on three sets of government proposals with the potential to shake up the industry.

Consolidation: DC schemes and the LGPS

The first two sets of proposals were announced by the Chancellor in November 2024. With the forthcoming Pension Schemes Bill, the government wants to encourage consolidation in the DC sector and complete the trend towards pooling assets in the Local Government Pension Scheme (LGPS). The idea is that greater scale will generate economies and encourage diversification, indirectly boosting productive investment in the UK. The government has its eye on Australia and Canada, where pension funds invest much more in asset classes such as private equity than their UK counterparts.

To encourage DC consolidation, the government proposes that schemes serving the auto-enrolment market could only offer employers a limited number of default options for their employees. Further, these would have to be of a minimum size. The government has not yet made a decision whether a “default” should be defined as default arrangements or as the first level of funds in which default arrangements invest. Much will ride on this, as will the way in which the policy is implemented.

A further proposal is a contractual “override” allowing contract-based DC pensions to be transferred to new providers without member consent in certain circumstances. The details of this proposal are perhaps less clear than those targeting default funds with, for example, the role of employers (if any) uncertain. However, like default fund reform, this is about consolidation. The government is concerned about the number of small and poorly performing pots; apathetic owners suffer accordingly. Of course, over in the trust-based pension world, there have long been bulk transfers without consent, subject to various stringent safeguards. DC trustees have more recently been required to consider if their schemes provide value for members, and if members would be better off with their savings elsewhere. In some ways, then, this represents an understandable convergence in the regulation of the two major types of private pension.

As for the LGPS, as it is a public sector scheme, the government can be more direct with reforms. These could have a significant impact: in March 2024, estimated LGPS assets amounted to some £392bn. The reason why both this government and the last have targeted the LGPS is that investments are not formally centralised for the 88 councils who are the scheme employers. Councils (or “administering authorities”) have in recent years been encouraged to pool assets, and progress has been made, with 45 per cent of assets pooled through eight pools. The key proposals are intended to build on this. Pools would be required to take the form of a proprietary investment management company regulated by the FCA, a model currently used by five pools. Councils would be required to transfer all investments to these pools, and to take their principal investment advice from them, effectively making them fiduciary managers. Governance mechanisms would be spelled out for all of this. Finally, there would be requirements to consider local growth opportunities in investment strategies.  

Back to the future? Mandatory return of surplus 

The third reform announced with an eye on growth concerns surplus in DB schemes. In recent years, there has been a dramatic change in many schemes’ funding positions; the Pensions Regulator estimated in January 2025 that 49 per cent were in surplus on a buy-out basis. The government’s own estimate is that trustees hold around £160bn in surplus, calculated on a prudent low-dependency basis.

Rules governing surplus vary greatly between schemes. In many cases, the rules do not permit a return at all. In other cases, trustees may be required, or are given discretion, to apply some or all surplus on additional benefits for members, with any remainder going to the employer. It is something of a rules lottery.

Legislation further complicates matters for returning surplus during the life of a scheme. Among other things, it requires that “the trustees are satisfied that it is in the interests of the members” to return surplus. This is a notoriously difficult test for trustees to meet. It is stricter than the common law where, to the extent that employers are a beneficiary or potential beneficiary of the trust, the trustee must consider their interests as well as those of members. There is also a member notification requirement. This creates a delay of at least three months and can be very expensive in practice: it involves mailing potentially thousands of members and having professional advisers deal with the ensuing correspondence.

In the eyes of the government all this means that there is a good deal of “trapped surplus”, often invested conservatively, so is inaccessible to UK plc. Legislating to mandate the return of surplus where funding exceeds some prudent level would cut through the difficulties, transferring cash to business and generating tax revenue at the same time. While this may sound like a radical idea, this was actually the law before reforms in the 1990s.

Prospects for unlocking UK investment

Driving the consolidation reforms is a view that scale – on the order of assets under management of at least £25bn-£50bn – is critical to access a wider range of investment opportunities. Examples include equity and debt financing of infrastructure projects, private equity, venture capital and unlisted equities. With more opportunities, the government expects that schemes will develop strong capabilities with illiquid assets.

If this were directed towards the UK, it could indeed boost domestic investment and growth. However, any such impact would likely only be felt in the medium to long term as the government envisages that DC reforms would be implemented only by 2030. On the other hand, it may be that the prospect of future mandated consolidation prompts change sooner than that – and in any event, the government expects implementation of LGPS reforms by March 2026. We would also expect DB surplus reforms to occur well before 2030.

The proposals have been met with a cautious response by industry, with scepticism that scale is the critical limiting factor on pension fund investment in the UK. Concerns have been raised that minimum size defaults could negatively affect competition, innovation and investment in smaller local opportunities. Better performing smaller schemes may also be penalised. A common theme has been that the government should focus on policies that could increase the attractiveness of UK investment, e.g. fiscal incentives such as removing stamp duty, reinstating the dividend tax credit for pension schemes and an industrial strategy that increases the range of attractive UK investment opportunities, for example through further planning reform. 

From a legal perspective, as so often, the devil will be in the detail – and there will be a lot of detail. We alluded earlier to the importance of how “defaults” will be defined in the DC reform, and how the reforms are implemented. These, of course, are just two of many intricacies. As for the LGPS proposals, there are questions over the extent to which a requirement to set local investment targets cuts across fiduciary duties, and the degree of control that councils will have over entities on whose success they will so much depend. On the DB front, for reform to be effective, the government will need to consider the broader legal framework that continues to make buying-out benefits with an insurer such an attractive option for many trustees and employers.

In fact, the government knows that its task is not straightforward. It has warned that if reforms do not work, it will consider whether “further interventions may be needed by the government to ensure that [they], and the significant predicted growth in DC and LGPS fund assets over the coming years, are benefiting UK growth”.

Should we be expecting reforms that are even more radical in the future?