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The SEC and FINRA are warning investors about the risks involved in selling or buying rights to pension or settlement income streams via products like pension loans, structured settlements or secondary-market annuities.
In a joint alert issued Thursday, Pension or Settlement Income Streams—What You Need to Know Before Buying or Selling Them, the SEC and FINRA urge investors to proceed with caution if engaging in such transactions.
As the alert explains, after acquiring the rights to a future income stream (such as a retiree’s pension payments), pension purchasing or structured settlement companies, sometimes called factoring companies, may turn around and sell these income streams to retail investors, often through a financial advisor, broker or insurance agent.
The products go by various names—pension loans, pension income programs, mirrored pensions, factored structured settlements or secondary-market annuities—and may be pitched to investors with words like “guaranteed” and “safe,” the alert explains. The sales pitch may also tout robust returns that outpace more traditionally conservative investments such as CDs or money-market accounts.
“The advertised returns may sound enticing, but investors should be aware that these investments can be risky and complex,” the alert says.
Gerri Walsh, FINRA’s senior vice president for investor education, said in a statement announcing the alert that “consumers should know that a series of potential pitfalls may greet anyone who is considering selling their rights to an income stream.” Any investor “who is tempted by the high yield offered by buying the rights to another person’s income stream should know that yield comes with high fees and considerable risks.”
For instance, when recipients of a pension or structured settlement sign over the rights to some or all of their monthly payments to a factoring company in return for a lump-sum amount, the lump sum will “almost always be significantly lower than the present value of that future income stream,” the alert says.
The alert goes on to note that most states require factoring companies that purchase structured settlements to disclose the difference between the lump sum payout versus the future income stream’s value. “In California, for example, the disclosure must identify the dollar amount of the payments being sold, the present value of those payments based on a federally established interest rate, the amount being paid to the seller, and the interest rate calculated as if the transfer were a loan and not a sale of the payment rights,” the alert says.
Fred Reish, partner and chairman of the financial services ERISA team at Drinker Biddle & Reath in Los Angeles, told AdvisorOne that a “fair amount” of litigation involving such deals has occurred on behalf of those in the military, where the transactions are “common practice.” Reish says he and others in the retirement planning arena expect such lawsuits to become more prevalent on behalf of private-sector pension holders.
The investor alert contains a checklist of questions investors should ask themselves before selling away an income stream:
- Is the transaction legal? Federal law may restrict or prohibit retirees from “assigning” their pension to someone else.
- Is the transaction worth the cost? Find the discount rate that the factoring company has applied to your income stream and compare this rate to alternatives such as a bank loan.
- What is the reputation of the company offering the lump sum? Check the factoring company’s record with the Better Business Bureau, and research the firm on the Internet and with a financial professional.
- Will the factoring company require life insurance? The factoring company may require you to purchase a life insurance policy, which will add to your transaction expenses and reduce your payout.
- What are the tax consequences? The lump-sum payment you collect may be taxable.
The investor alert also warns investors who might be attracted to the yield offered by buying the rights to someone else’s pension or structured settlement to be aware that:
- Investors may encounter commissions of 7% or higher.
- Pension and structured settlement income-stream products may or may not be securities and likely are not registered with the SEC.
- These products could be difficult to sell if you need money and want to sell the product.
- Your “rights” to the income stream you purchased could face legal challenges.
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