Be wary of trading your pension for structured settlement, lump-sum payment
Retirees shouldn't be surprised to hear that a pension check is so valuable that regulators are warning about the risks of schemes that promise a lump sum to those who are willing to sell off that income stream.
Ever hear of something called a “mirrored pension” that touts robust returns? If you're not careful, you could be looking at a “smoke and mirrors” kind of a deal.
Offers for upfront cash might sound tempting when budgets are tight. Maybe you do need a lump sum upfront immediately to cover a big medical bill. But think carefully before trying to get a settlement out of a regular pension, and do lots of research into various offers.
These deals are far more costly than many realize.
Or on the flip side, potential investors are being warned, too. In a time of ultra-low interest rates, new financial products pop up with big promises. A broker or financial adviser could pitch a financial product that supposedly is tied to an income stream. The promise is a high return, as an alternative to a low-paying CD. But connecting an investment to a structured settlement is risky and complex.
High yields in general come with high risks for investors and considerable fees.
“Our fear is that people don't understand just how bad these deals can be,” said Gerri Walsh, senior vice president for FINRA investor education.
And yes, some pushy salespeople are getting overly aggressive with elderly people about signing over their pensions. Retired government workers and retired members of the military are among those being targeted.
A “mirrored pension” or structured settlement shouldn't be confused with the one-time lump-sum payouts that have been made to former retirees by their old employers, like the General Motors and Ford offers that rolled out last year.
These are different deals, and structured settlements are way more costly for consumers.
Leon LaBrecque, CEO of LJPR, a fee-only financial adviser in Troy, Mich., gave one example. Take a 70-year-old with a $1,000-a-month pension.
A plan sponsor, such as an employer, looking to offer a lump-sum payout might offer a company's retiree something in the $140,000 range. By contrast, that same pension might net only about $75,000 in a structured settlement, LaBrecque said.
Structured settlements are promoted by outside salespeople.
A structured settlement can be filled with high fees for brokerage commissions, legal fees and various administrative charges.
“While a lump sum is appealing, you may well effectively be paying too much for that lump sum,” Walsh said.
A warning by FINRA said in some cases there may be “outright fraud.”
FINRA noted in its report that a typical structured settlement involves the resolution of a personal injury or workers compensation lawsuit, which often takes the form of “structured” or periodic payments made to the injured party. The periodic payments are commonly funded by an annuity issued by an insurance company, and are often structured to provide a dependable stream of income and a degree of financial security to the injured party.
The structured settlement industry notes that the federal tax code has recognized and encouraged the use of structured settlements as a way for accident victims to receive guaranteed, tax-free income tailored to their needs.
FINRA's warning pertains to those who are considering selling away their rights to a pension or structured settlement income and to people who may be considering buying secondary market products that carry various names, including factored structured settlements.
The range of names attached to these products also includes mirrored pensions, pension income programs, pension loans and secondary-market annuities.
Of course, you're likely to hear the words “safe” and “guaranteed” somewhere along the line, too.
“Selling off the security of a steady income stream for a lump sum is a recipe for even greater financial distress in the future,” warned Greg McBride, senior financial analyst for Bankrate.com.
“If someone sells their pension income stream because of a lack of cash today, what is the guarantee they'll have sufficient cash to live on in the future?” he asked.
Walsh recommends first talking to the plan sponsor to find out if opting for a settlement with a pension would even be allowed under the plan.
Regulators say you want to move carefully if you're being approached to sell rights to an income stream, like a pension or a settlement following a personal injury lawsuit.
Experts say to look at other options first. It may be better to find other ways to get cash, maybe even a loan from a 401(k) plan or through special programs at a credit union.
“Anyone with a structured settlement or a pension is potentially a target,” Walsh said.
Susan Tompor is the personal finance columnist for the Detroit Free Press. Email her at firstname.lastname@example.org.