Early Retirement Scams and How to Avoid Them

Losing Everything You've Worked For

After years of work, you’re finally facing retirement.  Perhaps, your company is offering you the option to retire early with an enhanced benefits package.  As this is one of the most important decisions in your life, and the lives of your family, the company arranges for financial advisors and other “retirement specialists” to assist you in making this important decision.  Many retirement planning seminars offer information that can be valuable for retirees.  But there are also those financial advisors that may mislead retirees about what kinds of investment returns they can reasonably expect, recommend risky and unsuitable investment strategies and portfolios, propose unsustainable withdrawal rates, or even commit outright fraud.  

The Financial Industry Regulatory Authority ("FINRA") has issued an Investor Alert, Help Your Employees Achieve Their Retirement Dream: Tips for Spotting Early Retirement Scams, which provides information to help companies protect their employees from being targeted by financial advisors that may not have their employees’ best interests at heart.  FINRA suggests that companies check the background of financial advisors hosting seminars and also review the information they provide to employees to ensure that they are not providing false or misleading information.  FINRA has also issued an Investor Alert to educate investors facing early retirement.  The Alert, Look Before You Leave: Don’t Be Misled By Early Retirement Investment Pitches That Promise Too Much, provides a list of things to consider before making the decision to retire.

Tips for Avoiding Early Retirement Scams

Here are a few tips FINRA suggests.  Check out the financial advisor recommending an early retirement strategy, either through your state regulator or FINRA’s proprietary BrokerCheck system. Confirm that they are registered to give financial advice and recommend investment strategies, and check their employment and disciplinary history for evidence of any previous fraud or wrongdoing.  Think long and hard about trading the certainty of a company pension for the uncertainty of investments whose values fluctuate with the market.  Make sure you understand Section 72(t) of the Internal Revenue Code which may impose an additional 10 percent tax on distributions from retirement plans made before the age of 59 ½.  This 10 percent early withdrawal penalty can be avoided, however, if the distributions from your retirement plan “are part of a series of substantially equal periodic payments.” Watch for the pitfalls!

Employees are often urged to retire early by financial advisors claiming that they can earn more money in retirement than they could if they continued working.  Beware of such claims.  Employees facing retirement are often told that if they cash out their guaranteed pension and invest in the market, they will enjoy returns of 12% or more annually.  These projections are often based on financial averages from the last four or more decades, and fail to account for the market’s volatility.  You should be cautious about relying on past performance as an indicator of future performance.  The market is volatile and unpredictable.  If a financial advisor’s projections seem too good to be true, they probably are.  And always be suspicious of any financial plan which projects that your nest egg will grow while supporting your living expenses.     

A financial advisor may also recommend that a retiree withdraw, say, 10% a year, and that their principal will remain intact or even grow since their account will enjoy returns of 12% or more annually.  But once 10% is chosen as the rate for their “substantially equal periodic payments,” a retiree may be stuck with that withdrawal rate.  Financial advisors often omit to explain that costs and fees in a portfolio or investment can have the effect of increasing the withdrawal rate above the anticipated returns.  Moreover, early market losses can be devastating on a retirement portfolio.  Remember, to recover from a 20% decline, a portfolio must grow (net of fees) 25%.

In a prominent 1998 study published in the AAII Journal, Trinity University Professors Cooley, Hubbard and Walz surveyed historical data between 1926 and 1995 in the U.S. and analyzed the chances of success for a retirement portfolio with various withdrawal rates, adjusted for inflation.  The Trinity study determined that a sustainable withdrawal rate for a retirement portfolio under a variety of back-tested market conditions was about 4% annually.  As the withdrawal rate increases beyond 4%, so do the risks that you will outlive your retirement nest egg.  Don’t get swept up in the hype of the market’s higher average returns, and don’t let a financial advisor talk you into an unsustainable withdrawal rate.  Sometimes you have to face the facts: You may not have enough money to retire!  If that is the case, keep the most valuable asset you may have – your job.

When considering whether or not to retire early, ask questions.  Make sure you understand the investment plan recommended to you.  Ask why this investment or plan is suitable for you.  This is your retirement and your money.  You should try to protect your assets by educating yourself.  Inquire about liquidity.  Find out if, and how quickly, you can access your funds in case of an emergency.  Make sure your financial advisor fully explains the IRS guidelines regarding 72(t) and early withdrawals if you are not yet 59 ½ years old.  The IRS provides a FAQ regarding 72(t) which can be found here.  If you can, get the broker’s recommendations, and the reasons therefore, in writing. 

Ask the financial advisor recommending early retirement to write down why the investment or investment plan is suitable for you.  If they guarantee or represent that you will earn a particular return on your investments, get that in writing.  This is the best way to protect against faulty memories which inevitably occur as time progresses.  If you suffer losses as a result of the financial professional’s recommendations, these written representations may prove invaluable.  In short, know what you’re investing in, and get it in writing.

Don’t remain silent if you think you have suffered losses as a result of following the advice to retire early.  Talk to your family, consult with your CPA or contact an attorney.  Don’t throw away everything you’ve worked for.