Pension loans and why you should avoid them

Short-term gain in exchange for long-term loss

It's a sad but unavoidable fact of life: no matter how bad your financial situation might be, there's always someone looking to enrich himself by making your already-bad situation even worse. And many of those “someones” have found the pension-loan (also called pension advance) business particularly profitable.

On July 1, the Federal Trade Commission released a consumer warning about the dangers of pension advance plans:

If you’re trying to make ends meet, here’s a pitch that might catch your interest:

“Convert tomorrow’s pension checks into hard cash today.”

Sound tempting? Think again. The Federal Trade Commission, the nation’s consumer protection agency, advises consumers that pension advances, also known as pension sales, loans, or buyouts, come at a very steep price.

Most pension advances require you to sign over all or some of your monthly pension checks for five to 10 years. The lump sum payment you get in return is less than the pension payments you sign over, so you’re signing over money you need to live on. And pension advances often require retirees to buy a life insurance policy – with the pension advance company as the beneficiary – to insure that the repayments continue.

The FTC release included a link to the agency's consumer information site “Pension advances: not so fast,” which points out other potential pitfalls of pension advance loans: for many loans, the annual interest rate exceeds 100%. Even for loans offering reasonable rates, there might be severe tax implications: “Getting a large lump sum can put you in a higher tax bracket.”

Better options

If you actually are in a financial situation dire enough that you're considering a pension loan, there are better and cheaper ways to resolve it. Among other things, the FTC advises checking with your local credit union to see if it offers short-term loans, or talk to your creditors about arranging payment plans.

For those people who have actually taken out pension loans, what were the results? An online search for the phrase “pension loans” suggests the loan recipients ended up in worse condition than before.

The first page of Google results for “pension loans” included an April 2013 New York Times story “Pension loans drive retirees into more debt,” a post about it titled “Pension loans still unregulated poison,” and a website for an actual pension-loan company whose pitch sounds an awful lot like that come-on the FTC warned consumers about: “Have you ever been short on cash and wished you could tap into your future retirement pension for funding?”

In the state of Maine, a group called Pine Tree Legal Assistance posted “Five signs of predatory pension loans” which apply to residents of all American states and territories. Two of them, the warnings against high interest rates and mandatory purchase of life-insurance policies, were already covered by the FTC. But PTLA also warns people to watch out for these signs:

1. Using the word “advancement” instead of “loan” – Companies try to hide their intentions by describing their offers as “advancements” rather than a loans. This is done for two reasons: to hide the truth from you, and to charge very high interest rates that are illegal in many states.

2. Targeting veterans or government retirees – People with government pensions are a favorite target for these lenders because of the guaranteed income. If you are a recipient of a government pension, be extra wary.

3. Encouraging you to [set] up a new bank account – Many of these companies will encourage their clients to agree to set up a separate bank that will be controlled by the company. They do this because they need to find a way around the law that says it is illegal for government pensions to be given over to third parties.

Incidentally, Pine Tree Legal's first warning – using some word other than “loan” – applies to other forms of debt as well. Savvy homeowners, for example, understand that the chance to “withdraw equity” from your house actually means “go into debt with your house as collateral,” and the only thing worse than going into debt is doing so by borrowing money from someone who isn't even honest enough to admit that “going into debt” is exactly what you're doing here.

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