If you have an asset, you can probably get a loan against it. Your paycheck, your tax return, your home, your 401(k) and, yes, even your pension if you’re one of the relatively few people who still has one.
If you’ve never heard of a pension advance, consider yourself lucky. They’re also called pension sales, loans or buyouts. Whatever the name, personal finance experts and government agencies advise steering clear of these products.
How They Work
A hypothetical scenario might go something like this:
You’re 65-year-old retired government employee. You receive a monthly payment from your pension, but recently you’ve fallen on hard times. You need more money than your retirement benefits pay each month to pay one-time bills. The sum you need is substantial, so you start looking around for ways to raise cash. You run across an online ad that offers a lump-sum advance on your pension payments.
When you contact the company, you have a hard time pinning down information about the loan, but you need the money badly so you go ahead. After you complete the paperwork, you learn that you have signed over 5 to 10 years – or all – of your pension payments to the company. (Sometimes people are forced to direct their pension payments to a different bank account attached to the company and purchase a life insurance policy with the pension advance company named as the beneficiary in case they pass away, according to the Consumer Financial Protection Bureau.)
Then you learn that the interest rate on the loan is upwards of 100% after all the fees. “Currently, these loans aren’t regulated by state and federal law because most businesses advertise them as advances instead of loans. The lack of regulation leads to abnormally high interest rates and fees,” says financial planner Kevin Michels, CFP®, Medicus Wealth Planning, Draper, Utah. You can also find yourself in a higher tax bracket for the year because the payment came as a lump sum.
This scenario may be hypothetical, but it’s very real in the lives of many retirees. Consumer advocacy groups advise finding other options if you need money fast.
If you’re receiving a military pension, definitely stay away: It is illegal for any loan company to take a military pension or veterans’ benefits.
If you find yourself in a financial bind, don’t get a pension advance loan. Try everything else first. Ask your bank or credit union if you are eligible for a short-term loan. Check with your credit card company about a cash advance (see How does interest work on a cash advance from my credit card?). The APR on a cash advance from your credit card is high, but by any standards it’s better than the terms on a pension advance loan. If you own your home, consider a home-equity loan or reverse mortgage (start by reading Reverse Mortgage or Home-Equity Loan?).
If you are not eligible for any other loan type, contact your creditors and tell them that you’re unable to pay and would like to negotiate a payment plan. This is a good time to contact a credit counseling agency. As a last resort, consider bankruptcy. In most cases your pension is safe if you file for bankruptcy, according to Michels. To understand more about this decision and its implications, read When to Declare Bankruptcy.
The Bottom Line
Even if you’re in a panic because of mounting bills, don’t sign away the source of income that you will need to live on going forward. Nearly every other financial option is better than a pension advance loan. There’s a reason the Federal Trade Commission and the Consumer Financial Protection Bureau, as well as personal finance experts, advise staying away from these loans.