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Beware pension advances that set retirees back

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Millions of seniors today are strapped for income because traditional interest-bearing investments are paying historically low rates. So it’s no surprise those with pensions are attracted to novel arrangements for converting future payment streams into current lump sums. The problem is, government regulators are now investigating so-called “pension-advance” firms for allegedly deceptive practices that target seniors, military veterans, and others with structured settlements.

In early May, New York Governor Andrew M. Cuomo directed the state’s Department of Financial Services to launch an investigation into pension advances, sending subpoenas to 10 companies that provide this service. “These companies are literally harvesting the hard-earned pensions of seniors, military veterans and other hard-working New Yorkers,” the Governor said. “Using deceptive practices to cheat people out of their pensions…will not be tolerated in our state.”

In a similar vein, the Securities and Exchange Commission and FINRA issued a joint alert warning consumers that selling their pension payments can result in high interest rates and fees. Other negative aspects include sales commissions of 7 percent or higher, potential tax liabilities, and the need to buy life insurance to cover the transaction. The Consumer Financial Protection Bureau and a Senate Select Committee are also investigating the industry.

In a pension-advance arrangement, a retiree signs away a portion of his or her weekly or monthly pension payments to a company in exchange for an upfront, lump-sum payment. The effective annual interest rates for such advances can sometimes exceed 100 percent, thus eating away a substantial part of the pension’s present value.

Given enhanced regulatory scrutiny, the National Ethics Association suggests advisors think twice about referring their clients to pension-advance firms or accepting commissions from them until regulators complete their work. Also, be prepared to advise clients who either want a pension advance or want to invest in such a program. According to FINRA, here are some questions they may wish to ask:

Questions for consumers who want to sell their pension payments:

Is the transaction worth the cost? Find the discount rate the factoring company has applied to the income stream to arrive at the lump-sum amount. This is the interest rate used to bring the future dollars received from the pension into today’s present value. The larger the discount rate applied to the pension payments, the lower its value in today’s dollars. Also take into account commissions, fees and other administrative costs.

What is the reputation of the company offering the lump sum? Check the factoring company’s record with the Better Business Bureau (BBB) and research the firm on the Internet. What complaints have been filed against the company? Were complaints resolved to the customers’ satisfaction?

Will the factoring company require life insurance? Pension-advance companies may require consumers to purchase a life insurance policy naming the factoring company or the investor buying the income stream from them as the beneficiary of the policy. This will add to the transaction’s total cost, reducing the consumer’s lump-sum payout.

What are the tax consequences? The payment may be taxable. Advise clients to discuss implications with their tax professional.

Does the sale fit with long-term financial goals? While consumers may feel they need money now, advise them to evaluate the future impact of the deal on their finances. Also have them seek the advice of an objective financial professional to see if the transaction makes sense. 

Questions for consumers who want to invest in pension-advance programs:

Is the financial professional selling the product registered with a state or federal regulator or with FINRA? Use standard due diligence resources such as state insurance or securities divisions, SEC’s Investment Advisor Public Disclosure (IAPD) website, and FINRA’s BrokerCheck website.

Is the salesperson authorized to sell this product? If registered, ask if the salesperson’s compliance department has reviewed the product and allows it to be sold.

What is the reputation of the company selling the product? In addition to checking out the person selling the product, check out the factoring company’s record with the Better Business Bureau and research the firm online.

What are the tax consequences? Consult with a tax advisor about the possible tax implications of purchasing pension or structured settlement income-stream products.

What organization is ultimately paying the consumer? The ultimate source of payment is likely to be a pension fund (if a person is purchasing a pension income stream) or an insurance company (if purchasing a structured settlement income stream). Consumers will want to check the financial stability of that organization.

How is the salesperson compensated? Ask the salesperson how he or she is compensated and how this impacts the purported rate of return.

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