Why Pension Advances Are a Really Bad Idea

People do crazy things when they’re desperate. But here’s a move that takes even desperation too far: selling the rights to your pension.

Why not cash in your pension?

A pension advance, as salespeople call it, doesn’t sound too bad, sort of like borrowing on your 401(k), right?

Wrong.

And, just to be clear, it’s not a good idea to borrow from your 401(k) either. But at least 401(k) loans are subject to lending rules that protect borrowers.

Not so, apparently, with pension advances, in which a company offers you a lump sum of cash now in exchange for the right to your pension checks for a period of time. These deals are unusually expensive for people using them to get their hands on quick cash.

The rules aren’t clear

It’s not clear what authorities, if any, oversee companies that offer pension advances.

The Government Accountability Office, in reviewing the industry’s business practices, recently contacted eight federal agencies with possible authority over pension advances. Each had reasons why it wasn’t conducting oversight or educating consumers.

“Federal laws clearly prohibit military retirees from assigning their pensions and the Internal Revenue Service code that covers private pensions also prohibits the practice,” says a Forbes article. Nevertheless, pension advance companies continue marketing to pensioners.

Interest rate: 46 percent

The GAO found 38 pension advance companies nationally. All were Internet-based, and at least 21 were affiliated with each other.

Their pitches may appeal especially to people in financial distress or those who, because of poor credit, can’t get a bank loan. The Federal Trade Commission explains how the deals work:

Pension advances, also known as pension sales, loans, or buyouts, require you to sign over all or some of your monthly pension checks for a period of time — typically five to 10 years. In return, you get a lump sum payment, less than the pension payments you sign over. So, unlike other types of cash advances or loans, taking out a pension advance means signing over money you need to live on.

The GAO describes the costs for consumers:

For example, the effective interest rates on pension advances offered to the GAO during its undercover investigation typically ranged from approximately 27 percent to 46 percent, which were at times close to two to three times higher than the legal limits set by the related states on the interest rates assessed for various types of personal credit.

Ask these questions

The advances are funded by investors who are looking for profit and an income stream. They, too, stand to lose money, the Financial Industry Regulatory Authority warns.

The FTC lists six questions to ask if you are considering selling your pension rights. Among them:

• What are the tax consequences for taking an advance?
• Will you be required to purchase life insurance naming the pension advance company as the beneficiary?
• Has the company been the subject of complaints?

Consider these seven alternatives

If your back is against the wall, here are seven safer sources of emergency cash:

• Try credit unions and banks. Don’t assume you can’t get a loan from a credit union or bank without first investigating. Lenders’ standards and policies have relaxed some since the post-recession credit crunch. “Some banks may offer short-term loans for small amounts at competitive rates,” the FTC says.
• Tap your 401(k). If you’re like most Americans, you’re going to need all the money you can get in retirement. Borrowing against it could lose you valuable growth. It’s risky, too: If you lose your job, you’ll have to repay the whole thing within 60 days. Nevertheless, it’s safer and undoubtedly cheaper than selling the rights to your pension.
• Talk with a finance company. Also called small loan companies, these typically charge higher rates, but they do make small, short-term loans, often serving borrowers with weaker credit.
• Shop around. Beat the bushes for the lowest possible cost of borrowing. Compare the APR (annual percentage rate) of each loan you’re considering and choose the lowest rate.
• Hit up family. It’s miserable to ask family members for a loan. But the embarrassment is better than an old age spent eating out of garbage cans.
• Get inventive. There are many ways you may not have considered to scare up hundreds and possibly even thousands of dollars. These tactics probably won’t solve the immediate problem if you need money fast, but they’ll help you pay back a loan faster. You’ll find dozens of ideas by searching Money Talks News.
• Tighten your belt. Even careful money managers can be hit by a true emergency for which they’re unprepared. But if your problem is more the result of careless spending, take heart: You probably can save quite a bit by trimming fat from your budget.

After you’re back on your feet, build an emergency fund to help keep the wolf from the door in case you’re in financial trouble again.