The opportunity to exchange monthly pension payments for a lump sum can be tempting to cash-strapped retirees facing rising costs or unexpected expenses, but federal regulators warn that the transactions pose investment risk and in some cases may be downright fraudulent.
Pensioned retirees and individuals receiving monthly payments from a personal injury settlement can be targeted by salespersons offering to buy the rights to some, or all, of the income stream, according to recent warnings issued by the Financial Industry Regulatory Authority or FINRA. The companies – sometimes known as factoring companies – may resell the income streams to retail investors.
The deals may meet an investors’ need for cash or income, but can also pose significant costs and investment risk, according to FINRA. Here’s a look at some of the drawbacks of buying and selling income-streams products. Those thinking of selling their rights to pension or settlement income should consider:
· How is the lump sum calculated? Factoring companies apply a discount rate to the income stream to determine the size of the lump-sum offer. The larger the discount, the lower the sum and, according to FINRA, “Typically the lump sum offered will be less – sometimes much less – than the total of the periodic payments you would otherwise receive.”
· What are the costs? Brokerage commissions, legal fees and administrative charges typically apply to the transactions, and the lump sum payment may be taxable. Some companies require sellers to obtain a life insurance policy and name the factoring company or purchaser of the income stream as beneficiary. Most individuals will also need to replace the pension or settlement income. “Be aware that some sales people can be aggressive or persuasive when trying to get you to sell you income stream,” warns FINRA, “and, in some cases, there may be outright fraud.” (Financial abuse of the elderly is on the rise. Click here to learn more about the issue.)
· Is the sale legal? Some pensions and settlements ban the sale of income streams. Investors are urged to check for any restrictions on sales, and to research the reputation of the factoring company.
Retail investors may consider purchasing pension or settlement income as an alternative to volatile stocks or low-yielding fixed-income products, which commonly advertise yields of 5.75 percent to 7.75 percent, according to FINRA. (Volatility has also increased the appeal of dividend stocks. Click here to learn more.)
Here’s a look at the investment risk posed by income-stream products:
· Costs: Investors may be charged commissions of 7 percent or higher.
· Transparency: The products are not likely registered with the U.S. Securities and Exchange Commission, and may not provide reliable information or a system for resolving disputes.
· Liquidity Risk: Income-stream products can be difficult to sell. Investors in need of cash may be forced to sell at a loss.
· Legal challenges: The rights to an income-stream may be subject to a legal challenge.
The investment risk associated with income-stream products is “substantial and the safety net if things go wrong may not be very strong,” FINRA warns. “Don’t shy away from asking probing questions – and shop around. There may be less risky alternatives to help you achieve your financial objectives.”