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Pension Advances Are a Shaky Deal for Borrowers and Investors Alike
Pension Advances Are a Shaky Deal for Borrowers and Investors Alike
If you receive a pension from your former employer, you may be the target of salespeople offering you a lump sum payment today in exchange for signing over some or all of your monthly pension checks for a future period of time—typically 5 to 10 years. The pitch goes something like this: “Turn your future pension income into cold, hard cash today!!! It’s your money, you deserve it.”
Even if you don’t have a pension, these same salespeople might approach you to invest in funding this type of loan or “advance” made to a pension borrower. In exchange for your investment of a fixed dollar amount, you are promised repayment of the amount invested plus a rate of return (typically 5.75% to 7.75%) for a set number of years. The money you invest is repaid to you—and you may be told that it is “guaranteed” or “secured”—by the pension borrower’s future pension checks.
Sound like a great deal for everyone? Think again. As a pension borrower, a pension advance can be very expensive, loaded with hidden costs and fees, and sabotage your long-term financial security as your pension checks are reduced or wiped out for years to come. As an investor, you may not be given reliable information about the risks of your investment, the commissions and fees charged by the pension advance salesperson or “broker” can be expensive, and your investment may be “illiquid” and difficult to sell. In addition, these pension advance transactions may be illegal and violate state usury (interest limit) laws, federal and state laws prohibiting the assignment or sale of a pension, or both.
Before you consider a pension advance or investing in someone else’s pension, you should know all the facts about these transactions and proceed with caution.
The Typical Pension Advance or Loan Transaction
Pension advances, also known as pension sales, loans, or buyouts, require you to sign over some or all of your monthly pension checks for a future period of time, typically 5 to 10 years. In return, you get a lump sum payment that will be less than the future pension payments you sign over. In other words, you are agreeing to give up the future pension income that you may need to live on in exchange for a reduced, one-time payment today. The extra amounts you pay are due to the “discount rate” that is applied to reduce the value of your future pension dollars to today’s present value. In addition, some of the extra amounts you pay will be pocketed by the pension advance salesperson as commissions or fees, and will also be used to repay (with interest) any investor who funded your pension advance.
Pension advances are an expensive way to borrow money, and include fees and costs that can push their “effective interest rate” or “annual percentage rate” (APR)—the cost of credit on a yearly basis—to over 100%. In addition, borrowers are often required to buy a life insurance policy to ensure repayment of the advance, which makes the transaction even more expensive. For some pension advance transactions, the borrower is required to set up a joint bank account with the pension advance company or investor and deposit his or her monthly pension check into this account so that repayments can be automatically and immediately withdrawn. It is also important to note that you cannot repay a pension advance early (which would save you interest and fees), because payments promised to the investor who funded your advance depend on extracting your pension benefits for the full 5- to 10-year period that you agreed to.
Pension Borrowers – Things You Should Know Before Getting a Pension Advance or Loan
- Do the Math – How Much Am I Really Paying? The lump sum payment you are offered for a pension advance will be less—and usually much less—than the total of the future pension payments you are sacrificing. Often, the fees and costs included in a pension advance are hidden or not fully disclosed. When these total fees and costs are included, the National Consumer Law Center found that the APR for a pension advance ranges from 27% to 106% a year. Know how much pension income you are really giving up--add up the total amount that will be taken from your future pension checks (plus any out-of-pocket costs you are required to pay) and compare it to the lump sum payment.
- Is the Transaction Legal? Michigan law prohibits the assignment or sale of any State or local pension benefits payable to a Michigan public employee. Similar federal laws either prohibit or restrict the assignment or sale of other types of pensions, including military pensions, federal employee pensions, and pensions from private employers. However, many pension advance transactions are structured in a way that effectively assigns or sells an interest in the borrower’s pension to secure repayment, which may be illegal. If the transaction is instead structured as a loan against your pension, then the interest rate cannot exceed 7% a year or it violates Michigan’s usury law. Before you agree to a pension advance or loan, learn how it is structured, talk to your pension administrator, and determine whether the transaction is against the law.
- Do You Also Have to Buy Life Insurance? To secure repayment, some pension advances may require you to buy a life insurance policy naming the company or person that funded your advance as the beneficiary. If you die before making all of your required payments, the life insurance proceeds will be paid to this beneficiary to cover any balance owed. If you are required to buy life insurance, this is yet another cost that you must include when calculating the total cost of a pension advance. It may also generate another commission for the pension advance salesperson.
- Consider Less Expensive Alternatives to a Pension Advance. Because pension advances carry effective interest rates that can top 100%, there may be several other ways you can borrow money more affordably. Consider a small loan from your bank or credit union, or from a small loan company licensed to do business in Michigan. If you are seeking a pension advance due to problems paying other bills, contact those creditors to explain your situation and ask about a payment plan or extension. Even a cash advance on a credit card may carry interest rates lower than the 27% to 106% charged for a pension advance. If possible, talk to an independent financial professional about these and other alternatives to a pension advance, as well as the impact a pension advance would have on your long-term financial goals.
- Tax Implications. The lump sum payment you receive may be taxable and put you in a higher tax bracket. Discuss the tax implications of any pension advance you are considering with a tax professional.
- Say “No” to Any Joint Account Arrangement. Never give a pension advance company or investor joint access to the bank account where your pension payments are deposited. This is the money you need to live on—do you really want someone else controlling it?
- Ask Questions and Get Everything in Writing. Ask the pension advance salesperson what “discount rate” was used to calculate your lump-sum payment, how much of your repayment the salesperson is keeping for commissions and fees, and how much of your repayment is being paid to any investor. Similarly, ask for the APR on your pension advance and a complete listing of all the costs and fees included to calculate this APR. In addition, confirm whether you can cancel the pension advance transaction and, if so, for how long. Most importantly, get all of these details in writing.
Pension Investors – Things You Should Know Before Investing in a Pension Advance or Loan
- Know the Risks of Investing in Someone Else’s Pension. Although the salesperson may tell you that your investment in a pension advance is “guaranteed,” “safe,” or “secure,” we all know there is no such thing as guaranteed money and every investment carries risk. These risks abound when investing in another person’s pension. Pension advances are legally suspect because they typically are not licensed or regulated, carry interest rates that exceed state usury limits, and may run afoul of state and federal laws that prohibit assigning or selling pension benefits. These legal risks translate into the distinct possibility that the pension advance you’ve invested in could be voided, or the borrower could stop making payments due to legal objections. Consider also: How do you recoup your investment if the pension borrower dies and the pension payments end? Or what if the company or government agency providing the pension payments discontinues its pension program or reduces monthly payments?
- Is the Investment a Security that Requires Registration and Disclosures? State securities regulators have concluded that an offer to invest in a pension advance or loan constitutes a “security” subject to registration and disclosure requirements. They also found that the salespeople offering these investments did not adequately disclose material facts needed for potential investors to make an informed investment decision. Ask the salesperson whether the pension advance investment you are being offered has been properly registered, as well as for company financial statements, a prospectus, and other documents adequately disclosing the risks associated with the investment.
- Is the Salesperson Registered with a State or Federal Regulator or FINRA? Check whether the salesperson is registered to sell securities, or has been subject to securities complaints or disciplinary action, by visiting the Securities and Exchange Commission’s Investment Adviser Public Disclosure website, FINRA BrokerCheck, or by calling the Corporations, Securities and Commercial Licensing Bureau of the Michigan Department of Licensing and Regulatory Affairs at 517-241-9202 or visiting its website.
- How and how much is the pension advance salesperson being compensated? Ask the salesperson how he or she is compensated, how much of your investment and the borrower’s repayment the salesperson is keeping for commissions and fees, and how this impacts the investment returns you have been promised.
- Selling Your Investment may be Difficult. Investments in a pension advance or loan are generally illiquid, meaning there is no established market for these investments and they may be difficult to sell. If you need money and want to sell or liquidate your investment, you may be stuck without a buyer or may only be able to sell at a substantial loss.
- Additional information about pension advances is available from the Federal Trade Commission.
- From the Securities and Exchange Commission.
- And from the AARP.
Contact the Attorney General’s Consumer Protection Division
Complaints about an advance or loan on your pension, or about investing in someone else’s pension advance or loan, may be made to the Attorney General's Consumer Protection Division at:
Consumer Protection Division
P.O. Box 30213
Lansing, MI 48909
Toll free: 877-765-8388
Online complaint form
Contact the LARA Corporations, Securities and Commercial Licensing Bureau
Complaints about an investment in a pension advance or loan may also be made to the Enforcement Division of the Corporations, Securities and Commercial Licensing Bureau, Michigan Department of Licensing and Regulatory Affairs at:
Department of Licensing and Regulatory Affairs
Corporations, Securities & Commercial Licensing Bureau
P.O. Box 30018, Lansing, MI 48909
LARA online complaint form