Reintroducing the generous tax relief, which allowed pension funds to claim a 20 per cent tax credit on the dividends they received, is a clear option

Labour should provide tax incentives to stimulate investment by pension funds into private markets, a former pensions minister has said.

Guy Opperman, who served in the role from 2017 to 2022, gave examples such as bringing back dividend tax relief.

This was a system where investors, including pension funds, received a tax credit on dividends which, in effect, increased the value of the dividends they received.

But Gordon Brown abolished the ability of pension funds to reclaim this credit in 1997, effectively ending their tax relief on dividend income.

This move has gone down in history as one of the major contributors to the demise of Britain’s generous gold-plated defined benefit (DB) schemes.

Although there were numerous other factors affecting pensions around that time, Mr Opperman said the removal of this tax break turned out to be very damaging in the years that followed.

He said: “If the Chancellor wants to stimulate investment by pension funds into private markets, then she should incentivise that investment. One option is the return of dividend tax relief.

“Other countries have this, and the pension funds cite it as a good example of the Government creating market conditions for the investment the Government wants.”

Mr Opperman said we would see a lot more domestic investment if dividend tax credits were brought back.

Before Mr Brown took the generous tax relief away, pension funds could claim a 20 per cent tax credit on the dividends they received.

But he argued that this system was effectively incentivising companies to pay out dividends instead of investing.

He said in his Budget statement that “many pension funds are in substantial surplus and at present many companies are enjoying pension holidays”.

Mr Opperman said Mr Brown raised several billion a year by abolishing the dividend tax credit that pension funds enjoyed at the time.

Worse still, the reduced incentive for UK pension funds to invest in British companies means that they and other institutional investors now own just 4 per cent of UK-quoted shares compared with half of them in 1997.

It comes as the recent Mansion House Accord showed 17 of the largest workplace pension providers in the UK expressed their intent to invest at least 10 per cent of their defined contribution (DC) default funds in private markets by 2030, with 5 per cent of the total allocated to the UK.

By investing a portion of pension funds into UK private markets, average savers could benefit from potentially higher returns while boosting domestic jobs, infrastructure, and economic growth.

Rachel Vahey, head of public policy at AJ Bell, said to really turn the dial on pension investment, the Government could look at “offering a carrot or two”.

She said: “Bringing back dividend relief for pensions could be one such incentive. It would certainly increase the attractiveness of the UK as an investment option for pensions.”

But she warned that at the time, this was frequently described as a “£5bn stealth tax” on pensions, meaning this could come with a hefty price tag.

Ms Vahey added: “It’s therefore possible that the Government might turn to sticks rather than carrots.

“Although it would like the pension schemes to meet their pledge to invest in UK firms, there is a proposed power in the recent Pension Schemes Bill that means if workplace schemes don’t make good on their promises, then the Government can mandate that they must invest in UK companies.

“It remains to be seen over the next 10 years whether the pension market will move voluntarily, or the Government may have to resort to using this power.”

Other suggestions from Mr Opperman include starting a tax break similar to the Enterprise Investment Scheme (EIS) for pension funds to provide investment finance in start-ups.

A Treasury spokesperson said: “The UK remains a highly attractive place for investment opportunities, thanks to the stability provided by the Government and our focus on growth.

“In the spending review we announced record investments in infrastructure and the industries of the future to unlock private capital. And we are tearing away the barriers to growth by overhauling our planning system and streamlining regulation.”