Pension Advance Loans: Why You Should Avoid Them
Pension advance loans are a type of debt that is collateralized by pension monies you expect to earn in retirement.
In some cases, you can only borrow a percentage of what you’ve contributed to your pension fund.
These loans are also known by other names depending on the way they are being packaged and offered:
- Pension advance
- Pension sale
- Pension buyout
Some people may confuse pension loans with loans you might take from your 401k or a similar type of retirement account like a Thrift Savings Plan (TSP).
Pension advance loans specifically refer to loans against pension accounts, whose contributions and retirement payouts are determined by the employer providing the pension.
The exact terminology for pension loans may dictate the legalities around this type of loan in your jurisdiction.
You should know that pension loan providers are largely unregulated which could result in minimal protections for borrowers.
In some jurisdictions, pension advances are not even legal.
In others, an employer may actually offer its pensioners loan options directly.
If you are exploring a pension advance as a loan option, know that it could be an extremely expensive and risky financial product. Before you commit to a pension loan, you should know how they work, associated risks, and as well as alternative lending options.
How Do Pension Loans Work?
Pension loans are not that different from other loans.
Like most loans, you will have to submit to an underwriting process to be approved for this type of loan.
Like any other loan, you’ll be required to pay back the loan with interest and other a specific period of time. Loan terms could range from 12 months up to 6 years.
Typically, you must already be retired to be eligible for a pension advance. In rare cases, you may be able to get a pension advance before you retire.
Once you are approved, your loan payments may be auto deducted from your checking account or jointly-held bank account with s representative from the loan company.
You may also be required to obtain life insurance naming the pension advance lender as a beneficiary.
How to Get a Pension Loan
If your employer has a pension loan program, you can reach out to the benefits administrator to start the process of applying for and obtaining a pension loan.
If you will be applying for a loan with a third-party institution like a bank or finance company, you’ll need to provide your personal information to start the application process.
When you work with a “pension sale” lender, you'll likely get an estimate for your lump sum payout once the application process is complete.
This offer will be based on a number of factors like the present value of expected future pension payments, your age, your employer providing the pension payments, years of service, etc..
Like other loans, you’ll sign a promissory note that discloses loan terms and other requirements needed to get your loan disbursement.
The loan company can give you a paper check or deposit the funds directly into your bank account once you are approved.
Between the high-interest rates and requirements to maintain life insurance at a later stage in life, the APR on these loans can become quite high.
Though companies may not disclose the exact interest rates for these types of loans outright, you can crunch some numbers during the final application stages to get an idea of what you'll pay in interest.
Because of the largely unregulated nature of the industry, some companies may be required to disclose the terms of the loans and related APR directly, and others may leave it to you to do the math on your own.
Some estimates put interest rates on pension loans anywhere from 27 percent to 46 percent!
Pension loans could be the wild-west of lending as there is not much oversight on these products from a legal perspective.
These lenders may even engage in predatory lending practices targeting vulnerable individuals like the elderly or those in unstable economic conditions.
For example, these firms may circumvent laws on predatory lending by simply changing the terminology used for this financial product.
Future financial impacts
A pension advance loan could adversely affect your spouse.
For example, if you have an outstanding pension fund loan, and something happens to you, your spouse may not be able to collect your pension payments anymore.
Also, if you are unable to make the monthly payments on the pension advance, your loan could be declared a taxable distribution, potentially increasing your tax liability.
Finally, if your pension payments are going to be used to service the loan debt, you’ll need an alternative form of income until the debt is totally repaid.
Access to large sums of money
If you have a very good pension plan with large monthly payments, you could qualify for a large amount of money that you wouldn’t otherwise be able to.
If you need money to consolidate your debt or spend however you need, a pension fund is a very viable option for people without other means.
Credit card and personal loans cap out at larger amounts and may not satisfy your need for a large amount of cash.
Lower credit scores not a problem
Since pension advances use your future pension payments as collateral, your credit score is not a huge factor in qualifying for the loan.
Even if you’ve got a low credit score, most lenders will approve your pension advance loan.
As mentioned, having a joint bank account with them and life insurance ensures that they will get their payments on time and as agreed.
As such, they are willing to take more risks with subprime borrowers.
Alternatives to Pensions Advance Loans
If you are strapped for cash, a pension loan could help you in a bind.
However, due to the relatively expensive nature of this loan product, it might not only be impractical but imprudent or even damaging to get this kind of loan.
The good news:
There could be plenty of lending alternatives depending on what you need a loan for.
For example, if you are in need of funds to purchase a home or perhaps do some home improvements, there are a variety of financial products and loan options that could work for you:
- 401k/TSP loan/withdrawal: There are special stipulations that allow you to borrow or withdraw funds for a home purchase.
- Self-directed IRA: This retirement account allows you to invest in real estate using an IRA.
- HELOC or home equity loan: Interest rates on these loans are reasonable and collateralized with the equity you have in a property.
If you won't be using your loan for home purchase or improvements, there are other options that might work for you:
Reverse mortgages, often federally backed, can provide monthly cash payments based on the equity in your home.
If you can get a reasonable APR, credit cards can help you finance direct purchases or obtain cash advances.
Credit cards are still expensive from a lending perspective but usually less risky than a pension advance loan.
This form of unsecured debt doesn't require an asset like a car or home to borrow against.
However, these loans can be especially difficult to get if you do not have a good credit score or sufficient personal income to make payments.
Car title loan
You can borrow against your car’s title to get this type of loan. Loan amounts are usually much lower and carry extremely high interest rates.
Should You Take Out a Pension Loan?
The average person would do well to avoid this type of loan if at all possible.
However, there could be some instances where this may be an only option.
If you are in a situation where more conventional loans will not work for you, it could be a lifeline in a dire financial emergency.
If you don't mind the higher fees, are comfortable with the potential effects on you and your spouse's future income, the pension loan could work out in your favor.
If possible try to exhaust all other avenues before applying for a pension loan.
Before making the decision, do your homework:
Research the pension advance company
Check their BBB profile or other review sites. Your state’s general attorney keeps business complaints on file which are public records.
You can request any information they might have on your prospective lender.
You’d do this for a mortgage or any other lender.
Do the same and compare fees, interest rates and other charges to get the best deal possible.
Have an exit strategy
Use the funds responsibly by having the most immediate exit plan possible.
This could mean paying off the loan early through investment gains, refinancing some asset, or having additional streams of income to pay the debt off faster.
If you need help researching your loan options, in general, you should check out some resources to understand the pros and cons of each lending path entails.
Benefits.gov offers a comprehensive section on federal loan programs along with BenefitsCheckup.org, operated by the National Council on Aging.