Sometimes it’s illegal to spend money you’ve set aside for yourself.
When you save money in many types of workplace retirement accounts, the IRS doesn’t collect income tax on that money until it’s time to withdraw it, when you’re older.
Do you need money before then? Certain types of “hardship” withdrawals are allowed. But you must have a very good reason and you definitely cannot lie about it.
Last week, a sentencing hearing took place following a rare case involving this type of legal violation. Federal prosecutors have won convictions against Marilyn Mosby, the former Baltimore prosecutor who may be best known for bringing charges against police officers in connection with the 2015 death of Freddie Gray, both for impermissible withdrawals and for making a false mortgage application when she bought a condominium in Florida.
Mosby will spend up to 12 months on home confinement absent a successful appeal or a presidential pardon, which she has requested.
Her case is complicated, as the ruling does not only apply to impermissible withdrawals. And her false claim of financial difficulties raising money from her city renovation account occurred during the 2020 coronavirus pandemic, when alternative, one-time rules were in effect.
Still, hardship withdrawals are widely available.
Below 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 lot of discretion in how they set the rules for their retirement plans, and there may be slight differences between the rules for 401(k)s, 403(b)s, and 457 plans.
Just to clarify: Can you really go to prison for taking money from your own workplace’s retirement savings account?
Yes. Although the judge allowed Ms. Mosby to avoid prison, prosecutors tried to put her there.
But that was her money, right?
Technically, the money belongs to the fund that holds the retirement plan, but there are many restrictions on what it can do with the money it holds for participants.
“It’s about the money in the plan that you have certain rights,” 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 now. ”
OK, but why are there any of these restrictions?
It’s a privilege to wait decades before paying income taxes the same way you do with workplace retirement accounts. In return, lawmakers want to ensure that 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) to withdraw money from retirement savings if it was something really bad.
Therefore, if your employer allows it, you can make a withdrawal if you are experiencing difficulties. What does “difficulty” mean? Start with whatever definition your employer provides, if any.
In its FAQ about these hardship distributions, the IRS states that withdrawals from 401(k) plans must be made due to an “immediate and burdensome” need and the amount must be appropriate given the size of the need. You should also have exhausted “other resources” before resorting to a hard withdrawal.
IRS examples of qualified needs that an employer may allow include medical expenses, education-related bills, the threat of eviction or foreclosure, and funeral costs.
Generally, you’ll pay taxes on hardship withdrawals and won’t be able to return the money to your retirement plan the same way 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 there are still taxes in many cases.
Hardship rules for workplace retirement plans changed in 2020, just that year. What was different?
The main change was a more flexible definition of suffering. People could withdraw up to $100,000 if, as a memo from Ms. Mosby’s retirement plan administrator put it, they suffered “adverse financial consequences as a result of being quarantined, furloughed, fired, experiencing reduced work hours, or otherwise unable to from working due to lack of child care.”
What difficulties did Ms. Mosby allege, and how did prosecutors convince the jury that this was not true?
Mosby maintained her day job during the pandemic, but also started some side businesses — before the coronavirus outbreaks began — that she said took a hit in 2020.
The jury did not believe his hardship was real, even though his 457 plan administrator, Nationwide, allowed him to withdraw. (She purchased two properties in Florida months after the withdrawals.)
Did federal prosecutors charge many people with committing 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 any, please send them to me.
Have people faced legal trouble for hard withdrawal scams in general?
There appear to be only a few cases in the last 20 years. Some involve individuals who lied about their circumstances and plans to obtain money. Others involve people who helped their colleagues make improper hardship withdrawals.
How much should I worry about getting in trouble for making an impermissible 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 stretch 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, employees can attest to the facts of their situation without needing to provide financial documents to the employer to prove their situation.
Without employers keeping workers under control, people may be more tempted to lie. If they do, it’s up to the IRS to detect it in any audit; in that case, you will almost certainly need documents to prove hardship.
What alternatives should people consider before making a hardship withdrawal?
If you are in a difficult situation, you may have already thought of most of the possibilities. But you might consider taking a loan from your workplace’s retirement plan if it offers that option. Just keep in mind that repeated borrowing can strain your savings and force you to work longer or retire with much less money.
Susan Beachy contributed research.