Labour's Pension Bill is not fit for purpose

It is said higher risk equates to higher return, perhaps now is high time for Britain to go risk-on

While most people in Britain probably see pensions as a bit of a dull topic - choosing instead not to worry about them until they approach retirement - the upcoming review and third reading of Labour’s Pension Schemes Bill is something we should all be paying attention to. 

Labour has effectively been trying to build its flagship Industrial Strategy around this bill, and for good reason. Fiscally speaking, it is much more viable for the government to fund its economic development aims through domestic or foreign investment flows rather than through the deployment of its own budget. 

With Labour’s government being beholden to some god-awful fiscal rules of their own design, every penny saved is a penny earned and so Starmer and Reeve’s cannot afford to let this strategy fail. However, while the Pensions Investment Review - whose recommendations lay the foundations for the Pension’s Schemes Bill - does correctly identify three problems with Britain’s pension sector: over-allocation of foreign assets, fragmentation, and risk-aversion, its recommendations miss the mark.

Where risk-taking behaviour is present, this only appears privately in Defined Contribution (DC) schemes. Here, households can manage their own investments and risk tolerance using platforms like Vanguard, but it just so happens that British households park a significant amount of their wealth in US stocks and Treasuries. 

To resolve this, the Pensions Bill aims to introduce a set of “Reserve Powers” which mandate investment for Defined Contribution (DC) schemes, if the voluntary approaches do not result in a significant shift of capital into UK assets (which they won’t). 

This legislation is worrying and goes against all market principles. There is a reason why UK investors prefer US equities, and that is because they offer greater historical returns than their British counterparts. US equities exhibit a clear path-dependency that no other market benefits from. I invest in US equities because I know that you will probably also invest in US equities. While the UK has outperformed the US since a year ago today, the general trend suggests that if you invested in the S&P rather than the FTSE, you’d be around two and a half times richer. 

The core behaviour of financial markets is that they accommodate demand for assets, and this is precisely why private pension funds favour non-domestic assets. In markets, demand creates supply, and if UK citizens want to invest in US or foreign equities to seek a higher yield, they should be allowed to do so. 

However, the state and the taxpayer should play no role in subsidising this capital flight. The 20% pension top-up is a form of tax relief, designed with the laudable public policy goal of incentivising people to save for their retirement. But when this UK taxpayer-funded incentive is overwhelmingly used to purchase foreign assets, it becomes a perverse state-sponsored subsidy for overseas markets. It is a great lapse in judgement to use British taxpayers' money to fuel the growth of the US stock market. A far more elegant and market-friendly solution exists: the Pensions Schemes Bill should be amended to limit this tax relief to investments made in British assets only, without resorting to the heavy hand of mandation.

While DC schemes are the most common type of private pension in the UK, they only represent one side of the coin. As of early 2025, the UK's total pension assets are estimated to be around £3 trillion but Defined Benefit (workplace pension) schemes, both private and public sector, collectively hold the majority of this wealth. However, their allocations tend to favour lower risk assets like long-term government bonds.

If Labour is serious about using this capital to fuel a national renewal, it must tackle the investment strategy of the public sector DB schemes. To do this, it needs a legislative approach that is far more radical, beginning with reforming the principle of fiduciary duty.

The concept of fiduciary duty, the legal obligation for pension trustees to act in the best financial interests of their members, is the shield behind which a culture of extreme risk-aversion hides. For private sector schemes, this narrow focus on maximising returns at minimal risk is appropriate. But for public sector schemes, which are ultimately backed by the taxpayer, it is an anachronism. The legislation must assert a modernised, broader interpretation: that the "best interests" of a public sector worker are inextricably linked to the long-term economic health of the nation they serve. A stagnant UK with crumbling services and higher taxes is a far greater threat to their retirement living standards than managed investment risk.

With this redefined duty as its legal foundation, the government should legislate to consolidate the dozens of fragmented Local Government Pension Scheme (LGPS) funds and other public schemes into a single, centrally managed pot. The current model, with nearly 90 different local authorities pursuing divergent, low-yield strategies, is an expensive and inefficient relic.

This reformed pensions strategy would have a clear and powerful mandate. Its core strategy would be to invest passively in a broad index of UK equities, automatically channelling billions into the engine of the national economy. The only deviation from this would be strategic, allowing the Chancellor to direct a percentage of the fund's allocation towards specific regions or sectors. If the goal is to level up the North, the fund can be instructed to overweight its investment in northern infrastructure and businesses. This transforms the public pension pot from a passive liability into the primary tool of an active, national industrial strategy.

Of course, such a change would be met with resistance from civil servants accustomed to the guaranteed safety of gilts. The solution is to offer a choice. Any public sector employee uncomfortable with this new, growth-oriented approach should be free to opt-out and instead open a personal Defined Contribution (DC) pension. The government could even continue to offer a reduced, but still attractive, employer pay-match to incentivise this option. The review has already floated the idea of a multi-employer Collective Defined Contribution (CDC) pensions scheme.

In doing so, we increase the appetite for riskier assets in Britain and since the return on an investment is essentially the reward for taking on additional risk, a simple logic follows: embracing risk will lead to higher growth.