It sounds like a win-win: Retirees looking for fast cash sell their future monthly pension payments, and individual investors who are buying them get steady income. But retirees on both sides of such transactions are getting hurt, regulators and consumer advocates say.
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State and federal securities regulators, along with the Federal Trade Commission and the U.S. Government Accountability Office, are casting a critical eye on "pension advance" transactions. In these deals, a consumer signs over to a pension-advance company a certain number of future monthly pension or disability payments in exchange for a lump sum, which can be significantly less than the value of the future payments.
In a typical transaction, the pension-advance company then sells that monthly income stream to an individual investor—often a retiree who's buying through a financial adviser or insurance agent. The deals unite a pensioner who needs cash with a retiree who needs steady income—but in the middle, there's "somebody taking advantage of both," says Christopher Vernon, a Naples, Fla., lawyer who has examined the deals.
For pension recipients, these transactions can be a costly way of raising cash. The effective interest rate on the deals often ranges from 27% to 46%, according to the GAO. In some cases, the agreements also require the purchase of life insurance naming the pension-advance company as beneficiary.
For investors, these seemingly safe income investments are fraught with risk. One major pitfall: Some pension-advance transactions have been invalidated in court because of federal laws prohibiting the "assignment," or transfer, of certain types of pensions.
Despite the regulatory scrutiny, Web sites such as Buy-My-Annuity.com and USPensionFunding.com continue to tout the benefits of pension-advance transactions. During a long period of low interest rates, the deals can attract income-hungry investors with advertised yields that often range from 5.75% to 7.75%, according to the Securities and Exchange Commission.
This summer, Missouri passed a law prohibiting pension advances for public employees, while a new Vermont law notes that the transactions can be treated as unlawful lending.
The GAO recently examined 99 lump-sum offers from six pension-advance companies. Almost all of the offers amounted to roughly half of the minimum lump sum that the pensioner could be offered by a private-sector defined-benefit pension plan under federal rules.
GAO also calculated interest rates for the lump-sum offers and found that most were well above the legal maximum, or "usury" rates, that some states have set for consumer credit. California, for example, has a usury rate of 12%, but the GAO found that pension-advance offers to California residents carried effective interest rates of 27% to 83%.
Although pension advances resemble loans, companies offering them often insist that they are not loans—and thus sidestep state and federal lending regulations. The federal Truth in Lending Act, for example, requires that lenders disclose to consumers an effective interest rate for each transaction, but most of the pension-advance companies examined by the GAO did not disclose this information. Absent such disclosure, consumers considering pension-advance offers often don't realize that they could borrow the same amount of money at a far lower interest rate, says Stuart Rossman, director of litigation at the National Consumer Law Center.
Even when the terms are clearly unfavorable, some retirees feel a pension advance is the only way to stay afloat. Pinched by the financial crisis in 2008, a retired Air Force major in Virginia agreed to sign over 96 months of military retirement pay—more than $230,000 worth of future payments—in exchange for a lump sum of about $104,000, according to bankruptcy-court documents. He knew that the transaction was essentially "a very high-interest loan," says the retiree, who asked not to be named. But he was struggling with a hefty mortgage, credit card bills and a declining income, he says, and "when you've got nowhere else to turn, you sometimes make poor decisions." After he filed for bankruptcy in late 2009, the court found that the pension-advance agreement was invalid due to federal laws prohibiting transfer of military retirement pay—and he was not required to make further monthly payments.
Before taking a pension advance, consider alternatives such as a bank or credit union loan, the FTC suggests. Your pension plan may also offer a lump sum in lieu of monthly payments. If you're struggling to pay bills, consider contacting a nonprofit consumer credit counseling agency, which can help you work out a debt repayment plan. Find an agency at the National Foundation for Credit Counseling (www.nfcc.org).
From the Investor's Perspective
Advisers selling pension- or disability-based income investments tout their predictable income and generous yields. Yet these investments often stand on shaky legal ground, and the income stream can quickly run dry. Investors are typically buying an individual's pension stream. In some cases pensioners simply stop forwarding the payments.
Lawrence Vicari, a 51-year-old engineer in Torrance, Cal., in 2012 invested roughly $62,500 in a veteran's disability income stream that was to pay him $750 a month for ten years, according to a lawsuit he filed last year against Little Rock, Ark.–based VFG, LLC, formerly known as Voyager Financial Group. Vicari had received less than a year's worth of that monthly income when the veteran stopped forwarding the payments, says Vicari's lawyer David Kupfer. "It was portrayed as a virtually fail-safe type of investment," Kupfer says, in part "because it involved the government."
The sale of the investment was unlawful due to federal laws prohibiting the assignment of U.S. government pension and disability benefits, and VFG knew, or should have known, that investors would be unable to enforce the contracts, Vicari alleged in his complaint. In its answer to the complaint, VFG denied the charge. VFG did not respond to a request for further comment.
While Vicari's case is ongoing, courts in some other pension-advance cases have found that the agreements are illegal and can't be enforced. In addition to military pensions, most other federal government pensions, certain state government pensions and large private pensions covered by the federal ERISA law are subject to anti-assignment rules, Rossman says.
What's more, commissions on these pension-based investments can amount to 7% or more, according to the SEC. And unlike traditional fixed-income investments, the pension investments may be difficult to sell.