THAT'S POTTY
What the new ‘pension megafunds’ plan by Rachel Reeves means for YOUR retirement
We explain what the changes mean for you
THE government is set to announce huge plans to create "pension megafunds" in a bid to boost both savers' retirement pots and investment in the UK.
Chancellor Rachel Reeves will outline the plans to move around £800billion of pension savings into larger so-called "megafunds" in her first annual "Mansion House" speech this evening.
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Local government pension schemes, which manage around £400billion of that cash, will be forced to split into eight megafunds.
Eventually, the plan is to then group all other defined contribution (DC) schemes - what most workers save into - into a number of other big funds.
DC schemes are where you and your employer both put money into a scheme and the cash is invested to grow your pot over time.
The plan is to set a minimum amount these funds can have in them - currently touted as somewhere between £25billion and £50billion.
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The government is also consulting on allowing fund managers - who manage where all this cash is invested - to move savers from schemes which are under-performing into schemes that will deliver them better value.
The megafund set-up is similar to the pension systems in other countries like Australia and Canada, where pension cash is pooled into huge so-called "superfunds" and invested on behalf of larger groups of savers.
Ms Reeves said the reforms are the biggest change to the pensions market "in decades" that will "boost people's savings in retirement" and "drive economic growth".
The government added: "Consolidating the assets into a handful of megafunds run by professional fund managers will allow them to invest more in assets like infrastructure, supporting economic growth and local investment."
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What do the changes mean for your money?
Currently, most workers in the UK are automatically enrolled into their workplace pension scheme.
These are usually DC schemes. The other type of pensions in the UK are "defined benefit" schemes, where workers receive a guaranteed income in retirement based on their years of service.
But "megafunds" will pool a number of workplace pension schemes together to create giant pots of money to invest.
The aim is that by having much larger amounts to invest, the cash returns on those investments will be far higher than having lots of smaller pots.
For example, if you returned 5% on £1,000 in a year, you would earn £50, but if you returned 5% on £100,000 over a year, you would earn £5,000, and so on.
This should mean savers should end up with much larger pots of money by the time they retire.
Having more cash also means investment managers can take more risk with their investments with the aim of achieving higher returns.
Looking at the bigger picture, the government is hoping that these larger pension funds can be used to invest in infrastructure projects, which will ultimately benefit everyone.
Currently, most DC pensions in the UK are too small to invest in any meaningful capacity in infrastructure projects, such as roads, railways or building developments.
But government analysis has found pension funds worth between £25billion and £50billion can achieve much greater "productive investment levels".
For example, it found Canada's pension schemes invest around four times more in infrastructure than the UK currently does, while Australia's pension schemes invest around three times more.
By combining UK schemes, the government estimates it could unlock a whopping £80billion to invest in the country's infrastructure.
Jon Greer, head of retirement policy at wealth manager Quilter, said that by pooling resources into larger funds, savers will access "high-yield investments that smaller schemes often miss".
"Drawing inspiration from successful models in Australia and Canada, this approach has the potential to deliver stable returns while supporting meaningful long-term projects," he added.
However, some pensions industry experts have expressed concern that the government's main focus is on investing in the UK rather than achieving returns for savers.
Tom McPhail, director of public affairs at consultancy The Lang Cat, said: "Consolidating schemes to drive greater efficiencies for savers and investment into the UK economy is great news in theory.
"However, I’d urge caution here with the leap of faith that the Government is making.
"While investment in UK infrastructure is welcome, surely where these schemes invest is down to the trustees and they may have other ideas on what will deliver the best returns for their members.”
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Tom Selby, director of public policy at AJ Bell, added: “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.
"If it goes well, everyone can celebrate - but it’s clearly possible that it will go the other way, so there needs to be some caution in this push to use other people’s money to drive economic growth."
How do pensions make money?
DEFINED contribution pension cash is pooled together to make money for savers.
Schemes are managed by investment firms, such as Hargreaves Lansdown or Fidelity, and fund managers at those firms decide where to invest savers' cash to earn as much money as possible.
Over a long period, these returns from investments gradually increase the size of the pot - and as the pot size increases, the amount it can return also increases, as the return is calculated on a larger amount of money.
This is known as "compound interest".
We have previously revealed how over 40 years, you could save a total of £109,671, while only paying in £40,000 of your own money because of compound interest.
The larger the amount of money is that's invested, the higher the returns can be in cash-terms for savers.
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