The government has fleshed out its plans for reforming the UK pension industry, including the creation of £25bn “megafunds” which will be instructed to make a portion of their investments locally to help fuel economic growth.

The chancellor said the overhaul, designed to follow the example of Australia and Canada’s huge pension investment funds, would also boost people’s pension pots.

“These reforms mean better returns for workers and billions more invested in clean energy and high-growth businesses,” Rachel Reeves said.

Seventeen of the UK’s largest pension firms already approved the gist of these reforms in a voluntary agreement earlier this month.

However, the government is also including a legislative back-stop, which will allow it to push through the new rules, if insufficient progress is made by the end of the decade.

The government has indicated it does not expect to use the new powers.

Nevertheless, that element may draw criticism, with some in the industry opposed to any government mandate over how and where investments are made.

“The challenge for investment into the UK has been finding good investments to make – and policy that may improve that supply side [is] probably just as important,” Chris Rule, chief executive of the Local Pensions Partnership, told BBC Radio 4’s Today programme.

He added that most pension funds “invest in the UK and locally anyway”.

Zoe Alexander, a director at the Pensions and Lifetime Savings Association, said the changes would have “significant implications” for how pension schemes operated.

But she added: “Increased consolidation has the potential to improve retirement outcomes through improved governance, wider investment diversification and improved bargaining power.”

Miles Celic, chief executive of The City UK, representing the financial services industry, backed the chancellor’s assertion that the move could “help drive economic growth”.

A former Liberal Democrat pensions minister, Sir Steve Webb, who is now a partner at consultants LCP, described the news as “truly a red letter day for pension schemes, their members and the companies who stand behind them”.

“The government has clearly been bold in this area and this opens up the potential for this surplus money to be used more productively to benefit scheme members, firms and the wider economy,” he added.

One of Labour’s first moves after taking office last year was the announcement of a pension review.

In November the chancellor floated her “megafunds” plan, which covers retirement savings for the majority of UK workers in two ways.

Firstly, there are the 86 different local authority pension schemes, which provide for more than six million people in their retirement, the majority low-paid women. The £392bn in these defined benefit schemes will be merged in just six asset pools by March next year.

In a defined benefit scheme a worker pays into their pension and is paid a pre-determined amount based on their salary and length of service.

Local investment targets will be agreed for local authority pension schemes for the first time, the Treasury said.

Secondly, defined contribution schemes currently worth £800bn, and covering millions of other private and public sector workers across the country, will also be consolidated.

In defined contribution schemes workers are not guaranteed a specific amount. Instead their pension depends on the performance of the fund in the years before retirement.

By 2030 the government says there should be more than 20 pension funds worth more than £25bn, in contrast to the current 10.

As part of the voluntary agreement, known as the Mansion House accord, agreed earlier in May, the 17 firms involved committed to investing 10% of their assets in things other than publicly traded shares, so that more money would flow into homebuilding, infrastructure projects and start-up businesses in fast-growing sectors.

In addition, 5% of investments will be earmarked to go into UK assets.

The reforms will form part of the Pension Schemes Bill, about to go before Parliament.

The new approach would mean over £50bn of additional investment in UK infrastructure, new homes and businesses, the Treasury said.

On Thursday the government is publishing the final report from its Pensions Investment Review.

It said the review found the reforms would drive higher returns for pension savers through cutting waste, economies of scale and improved investment strategies.

As a result workers on average earnings could see a £6,000 boost to their defined contribution pension pot, the Treasury said.