The House of Lords has handed Labour a second defeat over its proposed pension 'mandation' powers, rejecting the plans by 219 votes to 144.
Peers voted on Tuesday to block the measure, sending the Pension Schemes Bill back to the House of Commons in the latest stage of parliamentary “ping pong”.
Ministers had attempted to pass a revised version of the proposal last week after securing backing from Labour MPs.
However, opposition from across parties in the Lords prevented the changes from being approved.
The proposal would give ministers reserve powers to direct pension schemes to invest billions of pounds into private markets.
Under the plans, schemes could be required to allocate up to 10 per cent of their assets into private market investments.
Half of that amount would be directed towards UK-based assets.
The powers would remain in place until 2035, a timeframe that has drawn criticism from peers.
House of Lords blocks Labour pension mandation plan again as Bill sent back to Commons
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The policy was first introduced last summer and faced immediate resistance from parts of the pensions industry.
Critics argued the measure could reduce the independence of trustees responsible for managing pension funds.
After an initial defeat in the Lords last month, the Government brought forward what it described as a revised version of the policy.
Labour MPs approved the amended proposal in the Commons last Wednesday.
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Peers rejected the changes during Tuesday’s vote
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Baroness Altmann, a former pensions minister, said: "Forcing funds to buy high risk private assets by a legally required date is fraught with dangers.
"It could cause asset bubbles, investor losses and lower pensions."
She added: "The Government does not know best when it comes to investing for the long term and the timing of investments in private or illiquid assets cannot be shoehorned into a short timeframe."
Helen Whately, the shadow work and pensions secretary, said: "Mandation is still a reckless reach into people's savings.
"Politicians should not be allowed to gamble your pension investments on their latest pet project."
The Bill will now return to the Commons, where ministers are expected to consider further amendments.
The legislation is likely to remain under discussion ahead of the next King’s Speech.
Some critics have questioned the need for the proposed powers given the Mansion House Accord agreed last year.
Ms Whately said the attempt to control pension investments was dangerous
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That voluntary agreement involves 17 major pension providers and covers around 90 per cent of active defined contribution pension savers.
Signatories committed to investing at least 10 per cent of assets into assets designed to support economic growth by 2030.
Pensions experts have raised concerns that mandation could undermine trustees’ legal duty to act in the best interests of scheme members.
Tom Selby of AJ Bell said the Government’s approach risked using pension savings to support wider economic objectives.