Should we insist that pension tax relief be used to invest in UK companies? STEVE WEBB responds

I think it would be reasonable to insist that the tax relief paid on pensions should be invested in UK companies for UK projects.

Would it cause any fundamental problems if the rules were changed to ensure this happened?

Would pension companies be justified in complaining that this would increase costs/charges?

Steve Webb responds: With almost £2 trillion invested in UK workplace pensions, the government is understandably keen to get more of this money working to boost the UK economy.

But the level of internal investment in UK pension schemes has actually been declining rapidly in recent years.

If you look at the modern “pot of money” or defined contribution pensions, the government’s own figures (Pension fund investment and the UK economy) show that a decade ago just over half the money was invested in the UK, compared to less than a quarter now.

Given that defined contribution pensions are where the majority of new pension savings are invested, this is a matter of considerable concern for the government.

There is a very simple explanation for that recent trend.

Workplace pension schemes have largely stopped investing in the UK stock market.

Although pension schemes still own many shares (or “securities”), an overwhelming majority of these are now invested in stock markets outside the UK.

This particularly includes investing in things like technology stocks in the US stock market.

Pension plans would say there is a very good reason for this. Over the past 15 years, the rate of return of the UK stock market has been well below the performance of global stock markets.

For example, in the 2010s, investing in the largest companies on the London Stock Exchange would have generated an annual return of 5.5 percent.

But an index of global stocks would have returned almost twice as much (10.5 percent) and investing in the United States alone would have returned 14 percent annually.

That trend has continued into the 2020s, with UK returns so far averaging 4.2 per cent annually compared with 9.9 per cent for global stocks and 12.1 per cent for US stocks. .

As you can see, if someone had invested their pension in UK shares rather than the rest of the world or just the US, their pension pot would now be much smaller.

This is one of the reasons why successive governments have been cautious about forcing or even bribing people to invest more in the UK.

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If a government incentive led you to invest in a way that damaged the long-term value of your pension, you may not be too happy about this.

Even allocating just your tax relief to UK investments rather than putting it into the general fund would have given you a lower pension on average, and this would also lead to considerable administrative complexity.

However, the government has certainly not given up on getting a greater proportion of pension savings invested in the UK.

The new government firmly believes that if pension money can be invested in owning companies that are not listed on stock markets (sometimes called unlisted shares or private equity) or invested in boosting our infrastructure (for example, improving the National Network), then this will help generate economic growth and also provide decent pensions.

However, rather than forcing pension schemes to do this directly, the government has decided to achieve this by encouraging smaller pension schemes to consolidate into a small number of what it calls “mega funds”.

The government maintains that once pension schemes start to be in the £25bn to £50bn range they will invest much more in private capital and infrastructure.

Although it is possible to invest globally in these types of assets, there tends to be a much greater ‘domestic bias’ in these assets, certainly compared to investing in shares, where almost all money is now invested outside the UK.

Of course, the purpose of pension plans is to give us a decent income in retirement rather than to help the government with its financial goals, so a key question is what impact will all these changes have on our final pensions?

In this sense, the government’s own estimates are quite disappointing.

The government asked its own experts (the government’s Department of Actuaries) to model the final pension pot of someone earning £30,000 a year and paying an 8 per cent pension contribution for 30 years.

The model was modeled based on current investment approaches and a variety of alternative assumptions, including increased investment in unlisted stocks.

The results were quite disappointing.

The pension fund estimate after thirty years was £259,000, based on current investment approaches.

The size of the pot with a larger allocation to UK shares was also £259,000 and the figure for investing more in ‘private markets’ was £264,000.

While this last figure is “slightly higher” (as the government put it), they also stress that these figures are very uncertain.

The best we can say here is that if the schemes invest the way the government wants, then this probably won’t make much difference to people’s final pensions.

In short, although successive governments want more pension money to be invested in the UK, any pressure exerted a decade ago to invest in things like UK shares could have seriously damaged people’s pensions.

The government is therefore nervous about anything that appears to tell schemes how to invest, especially if the expert judgment of those running the schemes is that the best returns can be found outside the UK.

Instead, the government is trying to restructure the pensions market so that more pension schemes invest in what leads to economic growth in the UK.

It remains to be seen whether or not the changes they propose will lead to pension schemes boosting the UK economy.