Over the past several years, we’ve seen every manner of “financial innovation” which ultimately led to hardship. We’ve seen the securitization of mortgage loans which helped fuel the housing boom/bust, we’ve seen reverse mortgages leaving many seniors and heirs in the dust and now, there’s a major move afoot to buy pensions from Americans. Sure, the lure of immediate cash to replace future cash flows might sound good, but what if you’re being ripped off? (See How to Understand the Present Value of Money). There are probably a hundred reasons why this is a bad idea, but here are the top 5 that come to mind for me.
- The Whole Point of a Pension Is… to have a recurring source of monthly income for life. Often indexed to inflation, or even if not, it’s meant to be a safe, reliable source of income to supplement retirement needs, similar to Social Security. By selling a pension now for cash, all bets are off. Sure, you may feel flush with cash up front, but then run out of money quickly and regret having sold your pension obligations. This is just one of many financial miscalculations people make in life.
- You’d Get a Better Rate from a Bank or Other Sources! – In effect, you could consider a pension buying scheme equivalent to a loan. After all, with a loan you borrow a fixed upfront payment and pay it back in monthly installments over the remainder of the term. Here, a company is giving you that upfront cash payment and in exchange, taking all your future cash flows due to you via the pension. So, when looking at it in that light, when you factor in what you’re being paid, you’d often be much better off just borrowing money in other markets like through bank loans, cash-out refi, even peer lending. The interest rate (or expenses involved) with many of these firms are exorbitant – between 25% and 100% by some estimates! In effect, you’re not getting a fair shake. But many seniors don’t have the wherewithal to consider these calculations themselves.
- Shady Companies – Many professionals (and FINRA) are calling pension-buying outfits predatory. They often cater to seniors and employ a hard sell. Per the above point, if people knew what a bad deal they were getting and/or their other options available, many would opt to avoid the transaction.
- The Fine Print – There are some provisions that people selling a pension don’t even think about. One is the forced purchase of life insurance. See, if you sell a pension for a large cash sum and then die 2 months later, the investors would lose out. So how do they counteract that risk? By forcing you to buy a life insurance policy on yourself and assign them as the beneficiary. A further consideration is that when a pension has a cost of living adjustment, the company buying the pension gets to enjoy that whereas the settlement price of your lump-sum payment was just based on the current annual payment. Imagine over decades of cost of living adjustments how much more your pension is worth in present dollars compared to a flat-rate payout!
- What If You Live a Long, Healthy Life? The only way you win selling your pension is if you die quite a bit earlier than the actuarial estimates would predict. In the case where you were forced to buy life insurance and turn over the beneficiary to the settlement firm, the only loser is the insurance company. But who goes through life banking on dying early? Most of us plan on and strive for living past the median age utilized in actuarial tables. So, let’s say life expectancy is 83 when you begin collecting a pension at 63, but you live until 94. You would have sold your pension based on only 20 years of payments when you were really going to collect 31 years’ worth of payments had you not sold. That’s a massive misstep!
Would You Ever Sell Your Pension Rights?
Do You Even Have a Pension?
Would You Sell Your Social Security Rights for the Right Price (if you could)?