Retirees with plump nest eggs can be targets for unscrupulous financial advisers who rake in hefty fees with promises of huge returns
Stan Morrill was confident his nestegg would provide for him and his wife for the rest of their lives. After all, the Eastman Kodak (EK) veteran, a factory worker for 31 years, had attended the free financial seminar recommended to him by co-workers. Morrill says the host, Michael J. Kazacos, one of Morgan Stanley's (MS) top brokers, dazzled him with a plan that would let him retire at 49. Morrill just had to roll over his pension and 401(k) into a tax-deferred account managed by Kazacos. After that, he could safely withdraw $36,000 a year—plenty to cover his bills—without ever touching the $320,745 principal. "I saw no reason why I should stay and work," says Morrill, who signed on in 1998.
But he says the strategy, which assumed unusually high investment returns of up to 14%, didn't pan out. Morrill's balance now stands at just $57,559, and with little other savings, he's scrambling. At 59, Morrill doesn't yet qualify for Social Security benefits, so he has taken a job as a janitor at a local school paying $9.50 an hour. In April 2007 he and his wife, Cathy, sold the five-bedroom Victorian house in a suburb of Rochester, N.Y., where they had raised their two kids, and unloaded some inherited land in Florida. Now they own a modest ranch house on the outskirts of town. "It's all gone," says Morrill. "I've had thoughts of suicide."
Cases like Morrill's are becoming more common among America's 77 million baby boomers. If the Me Generation isn't careful, it could become the Poor-Me Generation. Over the next 20 years, a record $17 trillion will move from pension funds and 401(k) accounts into the hands of freshly minted retirees, says trade group Investment Company Institute. Not surprisingly, that money pot—and the fat asset management fees it will generate—has financial-services firms salivating.
The problem is that, like Morrill, many retirees and pre-retirees are woefully unprepared for the shift from "wealth accumulation," or saving and investing, to "wealth distribution," or drawing down those assets throughout their golden years. On June 24, MetLife (MET) research arm Mature Market Institute released a study showing that 69% of pre-retirees overestimate the amount of money they can safely withdraw from their accounts each year during retirement—many, dramatically so—while 49% underestimate their expenses. Likewise, a May study by the research group National Institute on Retirement Security found that about one in three households approaching retirement is at risk of running out of money.
Aggressive investment brokers are focusing on that yawning gap between perception and reality. Promising early retirement, fat investment returns, and big annual cash withdrawals, they're increasingly succeeding at seducing investors to turn over their retirement accounts—and then putting them in high-fee and often inappropriate investments. "This is emerging as a big problem," says Mary L. Schapiro, CEO of the Financial Industry Regulatory Authority (FINRA), the securities industry's private oversight group, which recently launched a program to train corporate benefits managers to vet financial advisers who run in-house seminars. "The issue has intensified for the next generation of retirees—the largest we've ever seen."
A Pitch for Products
Despite the increased scrutiny, in some ways it's getting easier for rogue advisers to operate. More are tapping into pools of workers from inside employers' offices. According to benefits consultant Hewitt Associates (HEW), 40% of companies with 401(k) plans now offer investment advisory services in which outside firms educate employees on financial issues—up from 28% in 2003. And those numbers don't include the many on-site seminars taking place without management's explicit consent. "The biggest challenge is the implied credibility of these meetings taking place at the workplace," says Karen Tyler, president of the North American Securities Administrators Assn., a group of state securities regulators.
The seminars can be breeding grounds for fraud. Last year federal and state regulators examined 110 securities firms and branch offices that offer so-called free-lunch sessions. They found most to be little more than thinly veiled sales presentations, with some suggesting unrealistic scenarios such as "how to receive a 13.3% return" and "how $100K can pay $1 million to your heirs." Under FINRA rules, brokers can't guarantee specific rates of return or promise investors they'll outlive their money.
"Investors should never lose sight that the goal of the seminar is to sell them products," says Mark Story, manager of investor communications for the Securities & Exchange Commission's Office of Investor Education & Advocacy. The regulators' study also found that 10% of the seminars appeared to be downright fraudulent, prompting investigations now under way.
In many fraud cases, brokers seek to take advantage of a little-known tax loophole that allows investors to tap into their 401(k) or other retirement accounts without penalty before they reach 59. Under IRS rule 72(t), enacted in 1974, investors can withdraw money from their tax-free accounts if they commit to take out the same amount each month for at least five years. "Clients get lulled into the belief that because this is a government exemption, these [moves] are blessed by the IRS," says Frederick Rosenberg, an attorney in East Hanover, N.J., who specializes in such cases. "Nobody ever shows you that there's more than a 50% chance you'll be destitute."
Preying on Vulnerability
Stan and Cathy Morrill have plenty of company in Rochester, the birthplace of Kodak and Xerox (XRX). In January a group of Kodak and Xerox retirees, including Morrill, filed a lawsuit seeking class action status in New York State court against Kazacos and another against Morgan Stanley broker David M. Isabella, with both suits also naming Rochester branch manager Ira S. Miller. The suits allege the brokers routinely targeted "unsophisticated" employees, often attracting prospects with "free advice" sessions held on company premises.
There, according to the suits, they told clients they could take out 10% from their portfolios each year and still have a "comfortable income for life." (Previous arbitration claims against the brokers made similar allegations.) Many advisers recommend withdrawal rates of between 4% and 6% a year