How the UK pension system is a massive Ponzi scheme

Charles Ponzi was born in Italy in 1882 and immigrated to Boston in 1903. In January 1920 he set up a small scheme that involved buying vouchers for cheap postage stamps in Italy which could also be exchanged for more expensive stamps in the United States - thus making a profit from the difference. However, he soon realised he could make a lot more money by using new money from new investors to pay returns to old investors. This delivered high returns to investors and thus grew incredibly popular and thus even more rewarding. However, it eventually collapsed on the 11th of August when it all came to light on the front page of the Boston Post.  

However, the central idea of the scheme of relying upon income from new investors to pay old ones ("robbing Peter to pay Paul") sounds slightly familiar - oh wait - that’s how our pensions work.  HM Treasury is running a £164.6 billion a year Ponzi scheme.

The state pension - in its current incarnation - relies upon current taxpayers to pay for the pensions of the elderly. In practice, this is a transfer system moving money from young taxpayers to the retired elderly. 

One of the first problems with this is that it is very vulnerable to demographic changes (specifically longer life expectancy). When the retirement age was fairly close to life expectancy then there may have been as many as 8 taxpayers per pensioner. However, as life expectancy has increased there may be only 4 taxpayers per pensioner. This results in either the taxpayers having to pay considerably more money in order to fund the same standard of living for the pensioner, the pensioner having to take a cut in their pension, or an increase in the retirement age to cut costs. The government will likely try to steer a middle way between the three options to spread the political fallout of such unpopular decisions. The result of this will be that each new generation will have to pay more in contributions, retire later and receive less in actual pension allowance. So a great deal for us to look forward to. 

Private pensions on the other hand are much more effective and much fairer. Firstly, they are not a Ponzi scheme but instead rely upon income that you save over your working life in addition to the interest that you gain on this invested income. This means it grows to be more than what you simply put in. Secondly, investing this money provides a lot of financial capital that can help firms finance projects helping to make the economy grow. Thirdly, state pensions are controlled by those whose self-interest is to be re-elected (and, in the case of conservatives, heavily reliant upon the elderly vote) and therefore are unlikely to try and make the tough necessary decisions to ensure its survival. Private pensions, on the other hand, are managed by private wealth managers who are motivated by competition to deliver the best long-term return on your savings thus working more in alignment with your own interest. 

In addition to this, the state pension provides an incentive against investing in a private pension. While many argue that the state pension is to supplement a private pension to ensure against old-age poverty it has evolved into something else. In fact, this is what it was originally meant to do as the 1908 Old-Age Pensions Act provided 5 shillings a week (slightly more if a couple) to those over the age of 70 whose annual means did not exceed £31 and 10 shillings. 

The argument for the state pension is that it is to supplement the private pensions in order to ensure that no-one suffers from old age poverty. But the state pension provides an incentive not to save more in a private pension. Most people work off the idea that there is a certain allowance they are happy retiring with. Therefore, if the state increases their expected allowance they will simply reduce the amount they put into their private pension. No matter how much the government promotes schemes to get more people to save it would never be as effective as removing the state pension. 

It is hard to change the system. To abolish state pensions overnight would leave millions in the lurch - to say the least. On the other hand, to abolish pensions in the future would mean those going into work now would have to pay for others’ pension but never get one themselves. Nonetheless, it is still a good idea to try and reduce the allowance many will receive in their state pensions to incentivise them to save more - and to reduce the burden on taxpayers. To do nothing will likely result in the whole thing crashing down, just as it did with Ponzi and his scheme.