By Iain Withers and David Milliken

LONDON (Reuters) - Britain's government wants many pension schemes to merge to become "megafunds" with at least 25 billion pounds ($34 billion) of assets by 2030, it said on Thursday, part of a wider drive to channel more investment into the economy.

The government also confirmed it would create a "backstop" power to potentially force investment firms to meet set allocation targets for illiquid assets such as domestic infrastructure projects. 

The new power - which the government says it does not expect to need to use - has been criticised by some investment firms who say it risks worse outcomes for pension savers.

Planned reforms will require pension schemes used by around 20 million Britons to merge if they are not already big enough, in a bid to emulate Australian and Canadian pension systems that feature fewer, larger funds which are better able to invest at scale.

"Basically everybody agrees bigger is better. That's not true for everything in life, but it is true for pension funds. We are just putting some wind into the sails of that existing process," Pensions Minister Torsten Bell told reporters.

The British government has been pursuing a range of policies to try to boost domestic investment, including signing up 17 investment firms to a pledge to pump 50 billion pounds of additional cash into UK businesses and infrastructure. 

Those targets could be made mandatory if the government exercises its planned new powers.

"The government says it will create a 'sword of Damocles' power in legislation.... This essentially puts a gun to schemes' heads and will create those mandatory targets in all-but-name," said Tom Selby, director of public policy at investment platform AJ Bell.

Pensions Minister Bell said the government was not directing specific investment strategies and the proposals reflected a consensus within the pensions industry.

Britain's Financial Conduct Authority said separately on Thursday it planned to request data from firms early next year on their asset allocations as part of the government's pension investment review.

'MEGAFUNDS'

The latest changes to create megafunds will apply to multi-employer defined contribution schemes and local government pension schemes, the government said.

Penalties will be applied to pension funds that do not meet the 25 billion-pound assets threshold by 2030, such as losing access to auto-enrolment contributions that would be diverted into larger schemes, a government official told Reuters.

Schemes worth over 10 billion pounds that are unable to reach the minimum size by that time will be allowed to continue, as long as they demonstrate a clear plan by 2035, the government added.

The government's push has caused consternation with some firms who worry it could lessen competition.

"Supporting UK growth is a worthwhile goal, but fiduciary duty must remain at the heart of any reform," said Martin Willis, partner at consultancy Barnett Waddingham.       

Local government pension schemes will also be given investment targets, and be told to combine assets split across more than 86 authorities into just six pools.

($1 = 0.7426 pounds)

(Reporting by Iain Withers and David Milliken; Additional reporting by Muvija M; Editing by Mark Potter, Emelia Sithole-Matarise and Sharon Singleton)