Sometimes it is illegal to spend money that you have set aside for yourself.
When you save money in many types of workplace retirement accounts, the Internal Revenue Service doesn’t collect income taxes on that money until it’s time to withdraw it, when you’re older.
Do you need money before that date? Certain types of “hardship” withdrawals are allowed. But you have to have a very good reason and you definitely can’t lie about it.
A sentencing hearing took place last week after a rare case involving this type of legal violation. Federal prosecutors had obtained convictions against Marilyn Mosby, the former Baltimore prosecutor who is perhaps best known for bringing charges against police officers in connection with the death of Freddie Gray in 2015, both for impermissible withdrawals and for submitting a false mortgage application. when he bought a condo in Florida.
Mosby will spend up to 12 months in house arrest, absent a successful appeal or a presidential pardon, which she has requested.
His case is complicated, given that the ruling is not just for inadmissible withdrawals. And his false claim of financial hardship in withdrawing money from his city retirement account took place during the coronavirus pandemic in 2020, when alternative, one-time rules were in effect.
Still, hardship withdrawals are widely available.
What follows are some questions and answers about what happened in Ms. Mosby’s case and what the rules really are. Keep in mind that employers have a fair amount of discretion in setting the rules for their retirement plans, and there may be slight differences between the rules for 401(k), 403(b), and 457 plans.
To clarify this: Can you really go to jail for taking money from your own workplace retirement savings account?
Yes. Although the judge allowed Mosby to avoid prison, prosecutors tried to put her there.
But this was his own money, right?
Technically, the money belongs to the trust that holds the retirement plan, but there are many restrictions on what you can do with the money you hold for participants.
“It’s plan money that you have certain rights to,” said Kelsey Mayo, an attorney and benefits expert based in Charlotte, North Carolina. “You may be entitled to the money, but you may not be entitled to the money right now. “
Okay, but why do some of these restrictions exist?
It’s a privilege to wait decades before paying income taxes like you can with workplace retirement accounts. In return, lawmakers want to make sure people use the money for their own old age and not for other things.
“If you want access at any time, don’t take advantage of the tax break,” Mayo said.
So how do these “hardship” exceptions work?
Lawmakers understood that things happen, but they only wanted to allow people (who haven’t reached retirement age yet) to withdraw money from retirement savings if they were really bad things.
So if your employer allows it, you can make a withdrawal if you’re struggling. What does “difficulty” mean? Start with whatever definition your employer gives you, if applicable.
In its FAQs about these hardship distributions, the IRS says that withdrawals from 401(k) plans must be made because of an “immediate and serious” need and that the amount must be appropriate given the magnitude of the need. You are also supposed to have exhausted “other resources” before resorting to a hardship withdrawal.
IRS examples of qualified needs that an employer could allow include medical expenses, education-related bills, the threat of eviction or foreclosure, and funeral costs.
Typically, you will pay taxes on hardship withdrawals and won’t be able to put the money back into your retirement plan like you can when you take out a 401(k) or similar loan.
Are early withdrawal rules different for individual retirement accounts?
Yes, they are more lenient, but in many cases taxes still exist.
The hardship rules for workplace retirement plans changed in 2020, for that year only. What was different?
The main change was a more flexible definition of difficulty. Individuals could withdraw up to $100,000 if, as a memo from Mosby’s retirement plan administrator put it, they experienced “adverse financial consequences as a result of being quarantined, furloughed, laid off, experiencing reduced work hours, or being unable to work due to lack of childcare”.
What difficulties did Ms. Mosby claim and how did prosecutors convince the jury that was not true?
Mosby kept her day job during the pandemic, but also started a couple of side businesses, before the coronavirus outbreaks began, which she says took a hit in 2020.
The jury did not believe his difficulties were real, even though the administrator of his 457 plan, Nationwide, had allowed his withdrawal. (He bought two properties in Florida within months of the withdrawals.)
Did federal prosecutors charge many people with similar crimes in 2020?
No. I couldn’t find any others, and the U.S. attorney’s office in Maryland declined to comment on the existence of other cases. If anyone knows of one, please send it to me.
Have people had legal problems due to hardship withdrawal fraud in general?
There appear to be only a handful of cases in the last 20 years. Some involve people who lied about their circumstances and plans for the money. Others involve people who helped their colleagues make improper withdrawals due to financial hardship.
How much do I have to worry about getting in trouble for making an impermissible hardship withdrawal?
If you tell the truth, you have nothing to worry about. But a recent change in federal law could make it easier for more people to misrepresent the truth.
One result of the Secure 2.0 Act of 2022 is that employers may be more likely to allow employees to self-certify their hardships. If an employer allows it, workers can attest to the facts of their situation without needing to provide financial documents to the employer to support it.
If employers don’t monitor workers, people may be more tempted to lie. If they do, it’s up to the IRS to catch it in any audit, in which case you’ll almost certainly need documents to prove the hardship.
What alternatives should people consider before making a hardship withdrawal??
If you find yourself in a difficult situation, you may have already thought of most of the possibilities. But you may want to consider a loan from your workplace retirement plan, if it offers that option. Just keep in mind that borrowing repeatedly could compromise your savings and force you to work longer or retire with much less money.
Susan Beachy contributed to the research.