Business

Why Ponzi is relevant to our own state pension scheme

Italian businessman Charles Ponzi
Italian businessman Charles Ponzi Italian businessman Charles Ponzi

HOW much will you depend on the state pension when you retire?

This is an important question, because there is a likelihood that the state pension when you are retiring may be markedly different - and possibly a lot less – than it is today.

To explain this, I have to go back to the early 1900s and mention a name that strikes fear into the heart of every financial adviser: Charles Ponzi.

Carlo Pietro Giovanni Guglielmo Tebaldo Ponzi was an Italian businessman who came to Boston in 1903 and, under the simpler name of Charles Ponzi, set up an investment scheme that has gone down as arguably the most famous financial con in history.

Ponzi’s investment scheme was fraudulent due to the fact that there was no actual investing involved.

The money paid into the scheme by new customers was not invested to feed profits into the scheme. Instead it was used to pay existing investors in the scheme – a classic example of ‘borrowing from Peter to pay Paul'.

Nonetheless it was fabulously lucrative for the charismatic and persuasive Signor Ponzi. He is reported to have made £250,000 a day, enough for him to purchase a luxury mansion with air conditioning and a swimming pool – very swanky in the early 1900s - in Lexington, Massachusetts.

Ponzi, whose aliases included Charles Ponci, Carlo, "LKaz" and Charles P. Bianchi, operated his scheme in both the US and Canada.

However, Ponzi's scheme began to unravel in August 1920, when The Boston Post began to investigate his returns. The investigation set off a run on Ponzi's company, as hundreds of investors attempted to pull their money out.

The investigations revealed that Ponzi had swindled investors out of $7m, which was a huge sum at the time. He went down in history as a legendary conman, and gave the financial world the new term ‘Ponzi scheme’.

In 1920 Ponzi was charged with 86 counts of mail fraud, and sentenced to 5 years in federal prison, the first of several terms he would serve.

Later he would declare to reporters: “I went looking for trouble, and I found it.”

So why is this relevant to our own state pension scheme here in the UK?

Well, the UK’s state pension scheme is often likened to a massive Ponzi scheme, in that it does not invest the money, but relies on a continuing supply of taxpayers and workers (the ‘Peters’) to pay for the pensions of those who have retired (the ‘Pauls’).

The problem with this system is that the number of Peters is falling in relation to the rising number of Pauls. Sooner or later, somethin’s gotta give.

This situation, sometimes called the ‘pensions time bomb’, gives me an opportunity to dish up another of my favourite financial terms: the ‘dependency ratio’.

Put in very simple terms, we are healthier and living longer than ever before. Average life expectancy a century ago was 60; today it is 81.

This means a much larger group of retired people living much longer retirements and drawing the state pension for longer.

Already it is forecast that by 2050 the dependency ratio (number of workers compared to the number of retired people) is set to change from 3:1 to 1:1.

In addition, we will be waiting for longer before we can draw our state pensions. The long-standing state pension ages were 60 for women and 65 for men, but due to our increasing longevity these are now rising, and are currently set to reach 68 for both men and women by 2046.

In its recent pension report ‘Mind the Gap’, Aviva said there are more than 1 million workers over the age of 65 in the UK, and they predict that the age 50+ cohort will become the biggest age group in the workplace in the next decade.

As a result, the burden of funding the state pension scheme will certainly rise, and possibly become unsustainable at current levels.

So those of us working today have to ask: how much of my retirement income will my state pension represent? As this demographic pressure cooker heats up, how will governments deal with the rising demands for funding by an increasingly healthy and long-living generation that have been dubbed ‘the wellderly’?

Ultimately, what will happen to my basic state pension, between now and when I retire?

All the evidence says: don’t count on the state pension alone to keep you in your retirement.

Find out what your workplace pension is likely to provide, you may wish to beef it up with additional voluntary contributions right away.

If you don’t yet have a workplace pension, then perhaps seriously consider setting yourself up with a personal pension; because there’s a possibility that future governments, faced with the spiralling cost of our state pension system, may shift the goalposts – and not in your favour!

:: Michael Kennedy is an independent financial adviser and pensions specialist, and can be contacted on 028 71886005