Pension or Settlement Income Streams—What You Need to Know Before Buying or Selling Them
Do you receive a monthly pension from a former employer? Are you getting regular distributions from a settlement following a personal injury lawsuit? If so, you may be targeted by salespeople offering you a lump sum today to buy the rights to some or all of the payments you would otherwise receive in the future. Retired government employees and retired members of the military are among those being approached with such offers. Typically the lump sum offered will be less—sometimes much less—than the total of the periodic payments you would otherwise receive.
After acquiring the rights to a future income stream (such as a retiree’s pension payments), these pension purchasing or structured settlement companies, sometimes called “factoring companies,” may turn around and sell these income streams to retail investors, often through a financial advisor, broker or insurance agent. These products go by various names—pension loans, pension income programs, mirrored pensions, factored structured settlements or secondary-market annuities. They may be pitched to investors with words like “guaranteed” and “safe”—and may tout robust returns that outpace more traditionally conservative investments such as CDs or money market accounts. The advertised returns may sound enticing, but investors should be aware that these investments can be risky and complex.
FINRA and the SEC’s Office of Investor Education and Advocacy are issuing this Investor Alert to inform anyone considering selling their rights to an income stream—or investing in someone else’s income stream—of the risks involved and to urge investors to proceed with caution.
What Is a Structured Settlement?
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.
Selling Your Pension or Structured Settlement Income Stream
In a typical transaction, the recipient of a pension or structured settlement will sign over the rights to some or all of his or her monthly payments to a factoring company in return for a lump-sum amount. And the lump-sum amount that factoring companies offer will almost always be significantly lower than the present value of that future income stream.
Most states require factoring companies that purchase structured settlements to disclose this difference. In California, for example, the disclosure must identify the dollar amount of the payments being sold, the present value of those payments based on a federally established interest rate, the amount being paid to the seller, and the interest rate calculated as if the transfer were a loan and not a sale of the payment rights.
Factors to Consider When Selling Your Income Stream
In uncertain financial times, you may find yourself searching for immediate cash to help pay for rising or unanticipated expenses. For example, even though your pension provides steady income, you may not feel it’s enough to make ends meet. At first glance, selling your future pension benefits might seem attractive, especially if mortgage, medical or other expenses loom. Under certain circumstances, these transactions may have their benefits.
However, there are several factors to consider before selling away the rights to your pension or structured settlement income. Transaction costs—including brokerage commissions, legal and notary fees, and administrative charges—can be high. You will need to think about how to replace the cash flow your pension or structured settlement income provides, especially if you depend on that income stream to pay monthly or other expenses. Furthermore, be aware that some salespeople can be aggressive or persuasive when trying to get you to sell your income stream and, in some cases, there may be outright fraud.
Before selling away an income stream you currently receive, ask the following questions:
Investing in Pension or Structured Settlement Income-Stream Products
Recent stock market volatility and a low interest-rate environment have caused investors to look for investments with attractive returns. Buying the rights to someone else’s pension or structured settlement income stream may look like a good alternative to other options because advertised yields from 5.75 percent to 7.75 percent are common. In a typical transaction, the investor buys an income stream product from a financial salesperson for a specific amount. In return, he receives a specific monthly income for a set number of years. While the yield in such a transaction may be attractive, investors should be aware of the following:
Before You Invest
Given these risks and complexities, ask the following questions before you invest:
Whether you are thinking about selling a pension or structured settlement, or buying one from someone else, remember that the risks in doing so are substantial and the safety net if things go wrong may not be very strong. Don’t shy away from asking probing questions—and shop around. There may be less risky alternatives to help you achieve your financial objectives.
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1 The assignability of pension benefits is addressed in the United States Code, including provisions governing military benefits within 38 USC §5301, civil service benefits within 5 USC §8346(a) and private pension benefits within 29 USC §1056(d).