Consolidation and megafunds: all change for DC schemes in 2025

The Labour government has made the pensions industry an area of priority following its general election victory last summer.

In 2025 we expect to see the Pension Schemes Bill laid before parliament and, in due course, the introduction of so-called “megafunds”.

The government is turning to the country’s collective retirement pot (one of the largest in the world with over £2trn in assets) to generate growth for the UK economy.

Labour has made it clear it intends to boost investment and tackle waste in the pensions system, and both the Pension Schemes Bill and the creation of megafunds will look to achieve this goal by facilitating larger, more cost-efficient pension schemes.

The Pension Schemes Bill aims to create a private pensions market that encourages consolidation of small pension pots and generates ‘value for money’ for pension savers. The government claims that it could increase pension pots by over £11,000, or 9% at retirement for an average earner through these reforms.

Megafunds on the horizon

The headline development from chancellor Rachel Reeves’ Mansion House speech on 14 November 2024, for pensions at least, was the proposed creation of megafunds modelled on large pension schemes in Canada and Australia.

The Chancellor’s key measures include plans to:

• Impose minimum size requirements on multi-employer defined contribution (DC) schemes, requiring £25bn or potentially £50bn of assets under management; and

• Accelerate the pooling of the assets of the 86 Local Government Pension Scheme funds in England and Wales by March 2026.

The incentive behind consolidation is that larger funds may be able to operate at a lower cost – benefiting from economies of scale – and they can also make bigger and potentially higher-yielding investments, such as infrastructure, start-ups and private market assets, to secure a better return for pension savers.

The government is consulting on the minimum size for DC schemes as well as on the number of default funds that each provider may operate.

A key issue that remains up in the air is whether the government will encourage or force these larger funds to invest in UK assets.

While the chancellor has ruled out mandating funds to make domestic investments for now, pensions minister Emma Reynolds has more recently noted the possibility in an interview with the Financial Times, explaining that any requirement to push a higher allocation into UK assets would be “left to the second bit” of the pensions investment review.

The basis for doing so is data that show that around UK pension funds invest around 4.4% on average in domestic equities – lower than the global average of 10.1%. In addition, just 2% of DC schemes’ assets are invested in private markets such as unlisted British equities and infrastructure.

The potential that the government could legislate to prescribe investment in UK assets may cause problems for trustees having to comply with their duty to invest scheme funds as if they were their own, if for example there are concerns about potential returns.

How trustees square the circle of maximising returns while complying with any statutory duty to invest in the UK remains to be seen.

Rachael Healey is a partner at RPC.