The SEC and FINRA issued a joint Investor Alert warning of risks inherent with buying or selling pension or settlement income streams, including those related to a structured settlement.
What both pension and settlement income streams have in common is a regular distribution—such as a monthly pension from a former employer or a quarterly distribution from a personal injury lawsuit settlement. The idea is that structured settlements, for instance, will pay regular yet smaller distributions until a certain level of funds have been paid out.
A structured settlement's period payments are often funded by an insurance company's annuity and are intended to provide a dependable, consistent stream of income to an injured party, thereby affording financial security. Pension payments are constructed in a similar fashion.
The investment salesperson's pitch related to pensions and structured incomes generally involves the draw of receiving a larger lump-sum payment up front in exchange for signing over the rights to some or all remaining monthly, quarterly, etc. payments.
The catch of receiving a lump-sum payment in lieu of a continued revenue stream, however, is that the lump-sum payment offered is often significantly less than the value of the future income stream. In other words, the one-time lump-sum payment will generally be less than the sum of all future structured distributions, often significantly so.
If you are considering selling your income stream or the rights to future pension payments, consider the following:
>> The transaction itself may not be legal. For instance, federal law may restrict retirees from assigning pensions to someone else while the Uniform Periodic Payment of Judgments Act requires a court to approve the secondary sale of most structured settlements.
>> Ensure the company offering the lump sum is well reputed.
>> You may have to purchase life insurance. Some factoring companies or pension payment sales may require the purchase of a life insurance policy in order to complete the transactions. Furthermore, this life insurance policy may require you to name the factoring company as the beneficiary of the policy, all of which will add to your expenses.
>> Your lump-sum payment may be taxable. The SEC recommends discussing such tax liability with an accountant or other tax professional.
>> As specified above, the transaction may not be worth the cost. The factoring company will apply a discount rate to your income stream to determine the lump-sum amount. For all intents and purposes, this is an interest rate that converts future dollars you would have received from a pension's regular payments to today's present value, with the larger the discount value applied corresponding to a lower lump-sum value. Commissions, fees and other administrative costs may also factor into your final "take home" pay.
In California and most other states, the law requires that factoring companies disclose the difference between future income streams and lump-sum payments. For instance, if your pension of $500 per month was set to continue for 10 months, for a total of $5000, and a factoring company offered a lump-sum payment of $2000 in exchange for selling away the income stream, the difference reported would be $3000, which is $5000 minus $2000.
Before you invest, locate and consider this difference amount.
Additionally, FINRA recommends you ensure that the financial professional selling the product is registered with a state and/or federal regulator, such as FINRA. Such regulators offer free services such as FINRA BrokerCheck through which investors can research a broker or financial advisor.
Furthermore, the SEC suggests following the money trail:
>> Who is sending the check? The contract you sign should specifically detail who will be responsible for sending payment.
>> What organization is ultimately paying you? The SEC points out that in the case of a pension income stream, payment will likely come from a pension fund while in the case of structured settlement income streams, payment will likely come from an insurance company. Financial stability of the organization paying you is key because if that entity goes bankrupt or otherwise financially insolvent, it may stop paying you.
>> How is the salesperson being compensated? Sometimes method of compensation impacts the purported rate of return. Other times, for instance if a commission rate is high, a salesperson or broker may be tempted by ulterior motives to make an unsuitable recommendation.
If you have sold away your rights to a pension or settlement income stream and have suffered from any of the risks detailed above—illegality of the transaction, a company, broker or firm's poor reputation, requirement to purchase life insurance, tax liability incurred as a result of a lump-sum payment, entities unclear about who will send payment—or because of any other indications that a broker or firm has engaged in misconduct that has proven detrimental to your investments or interests, please call The Law Offices of Jonathan W. Evans & Associates at (800) 699-1881 for an investigation and consultation.
Investor Bulletin: Pension or Settlement Income Streams (SEC)