2 sue state over penalties for pension withdrawals

September 25, 1990|By Michael K. Burns

The first in an expected flood of claims against the state were filed yesterday by two people who blame the State Retirement Agency for the hefty income taxes and penalties they owe after withdrawing money from the state pension plan.

The two claims, for $30,000 and $10,000 in taxes, penalties and interest paid the state and federal governments, were filed with state Treasurer Lucille Maurer by lawyer Joel C. Denning of Towson.

The state has six months to pay or deny the claims, then the claimants would be allowed to sue in Circuit Court.

"We expect to be filing a number of these in the next few weeks," Mr. Denning said, noting that his firm of Mann & Whelley has talked with nearly 50 people who believe they owe substantial income taxes as a result of an Internal Revenue Service ruling in July.

"The state misled these people negligently, and it cost them dearly," he said.

The notices of claims were filed yesterday by Caroline McBee, an Arbutus clerical worker for the Department of Public Safety and Correctional Services, and by an unnamed Baltimore high school teacher, Mr. Denning said.

As many as 3,000 people withdrew from the state's old pension plan between 1987 and 1990, lured by the promise of higher interest rates -- about 15 percent annually -- paid on their contributions over the years. Most switched to a new state pension plan.

Withdrawals for some career employees topped $300,000. Millions of dollars in taxes and penalties, and interest on unpaid taxes, may be at stake, experts estimate.

Many of these people claim they were misled by the agency to believe the withdrawals would be tax-free if they rolled over the money into another retirement fund, such as an individual retirement account (IRA). Tax-free rollovers were permitted prior to the 1986 federal tax reform.

The retirement agency asked the IRS in August 1989 for a ruling; the IRS wrote in July that the lump-sum withdrawals were not eligible for tax-free rollover. The federal tax agency denied a state request to forgive taxes due on withdrawals, and instead asked the retirement agency for the names of people who had withdrawn pension money.

Between 2,000 and 3,000 people may have been affected by the tax ruling, depending on what taxes they may or may not have paid, state officials say.

Agency officials maintain that individuals were not purposely misled by publications or retirement counselors about their potential tax liability. Employees were told to consult competent tax advisers and the IRS, the agency insists.

But Herbert Dyer, executive director of the agency, conceded that some counselors may have inadvertently given misleading tax advice, contrary to agency policy, and that some agency literature may have been misinterpreted in determining tax status of withdrawals.

The retirement agency insisted that it never advised employees to withdraw their money from the old retirement plan and switch to a new state pension fund. But the state had created the new fund in 1980 because the old pension fund was becoming too costly to maintain.

State employees and teachers get lower benefits under the new fund, but do not have to make contributions from their pay; they paid between 5 and 7 percent of their salary into the old plan, which paid higher benefits pegged to cost-of-living increases.

Meanwhile, a Washington lawyer said he is organizing a coalition of Marylanders to seek legislative and legal relief from the IRS, Congress and state tax officials. "People who devoted a lifetime to government service should not be penalized for having relied in good faith upon the advice of their government," said Thomas J. O'Rourke.

The coalition is asking the IRS to forgive any penalties due from pension withdrawals and is mobilizing to press for legislation in Congress and the Maryland General Assembly, he said.

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