Retirees on a fixed income who find themselves faced with a sudden financial crisis may be attracted to the idea of trading future payments from their pension plans for an upfront lump sum. However, these “pension advances” are rarely a good idea, and better alternatives exist for relieving the pressure. If you are considering a pension advance, please consult with a consumer law attorney first.
What is a Pension Advance?
Pension advance companies target retirees through television and online ads, offering to pay them a lump sum in exchange for a certain number of future pension payments, typically five to ten years’ worth. These advances are attractive because they give the retiree access to an immediate large lump sum, but there are numerous pitfalls.
Why Pension Advances are a Bad Idea
Pension advances are just another way that the financial services industry takes advantage of cash-strapped consumers. There are a number of reasons why you should think twice before signing away your pension payments:
Pension advance contracts may violate all sorts of rules and regulations – because these contracts are marketed as “purchase agreements” instead of high-interest loans, they are designed to circumvent many state and federal consumer protection laws. Many courts have found these types of contracts to be invalid. The questionable legality leaves the retiree at risk of having to repay the advance after the money has already been spent:
Anti-assignment restrictions – in order for a pension advance to work, the retiree has to transfer their right to the payments to a third party. But many, if not most, pension plans forbid such transfers (called “assignments”).
State licensing requirements for lenders – several states have sued pension advance companies for issuing loans without a state license.
Federal consumer disclosure rules - the Consumer Financial Protection Bureau is currently suing pension advance companies for failing to accurately disclose the true cost of these loans.
A really, really bad value – the costs associated with these types of transactions are exorbitantly high and are almost never disclosed up front. These may include:
Effective interest rates ranging from 27% to 46% or more - the advance is in essence a loan, and the amount of interest paid on an annualized rate often exceeds the usury rate for many states. Also, these costs are not usually disclosed in the pension advance contracts.
Commissions and other fees– these transactions typically involve all sorts of fees that jack up the costs.
Premium costs for required life insurance– retirees are often required to take out a life insurance policy naming the pension advance company as the beneficiary to guarantee the future payment stream, and the retiree has to bear the cost of this insurance.
Tax Consequences– receiving a large payment all at once may push the retiree into a higher than anticipated tax bracket for the tax year when the payment was made.
Alternatives to Pension Advances
If you are facing a cash crunch and are tempted to take out a pension advance, here are some other options with less cost and risk:
Does your pension plan offer a lump sum payment option? Check with your pension plan to see if this is an option.
Can you borrow from a credit union, against a life insurance policy, or a line of credit secured by your house? All of these are cheaper, better options that might give you greater flexibility regarding repayment terms.
Can you negotiate better payment terms for your current debts? Renegotiating your current debts may give you the breathing room you need to resolve your current crisis.
A consumer law attorney can help you consider your options and find a path through your financial crisis. Before signing away any of rights you have to future income, make sure to consult with an attorney first.