How N.J. taxes retirement withdrawals

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Q. Is it correct that while you can make pre-tax contributions to a 401(k) plan, you can’t for New Jersey’s deferred compensation plan for state workers? How does that work, and if the contributions aren’t pre-tax, how are they taxed when you take the money out? Is it the same if you take a monthly payment versus a lump sum?
— Planning ahead

A. New Jersey tax rules don’t piggyback the federal rules. It can make taxes more confusing because some income and deductions are handled differently.

It sounds as though you participated in a Section 457 plan, an eligible deferred compensation plan of a state or local government or tax-exempt organization.

Any contributions you have made to the Section 457 plan were not deductible and therefore were included in your New Jersey wage income when made, said Neil Becourtney, a certified public accountant and tax partner with CohnReznick in Eatontown.

“Accordingly, when you receive distributions from the plan, you will only be subject to New Jersey tax on amounts you receive in excess of the total contributed,” Becourtney said. “This differs from the federal treatment where your contributions were fully deductible, reducing your yearly federal wage income, resulting in fully taxable distributions.”

You will need to determine the taxable portion and excludable portion of yearly plan distributions, Becourtney said.

New Jersey has two different rules for this.

“The `Three-Year Rule’ can be used if you will receive an amount equal to or greater than your total contributions within 36 months from the date of your first plan distribution,” he said. “Until distributions exceed the total contributed, they are received tax-free.”

If you will not recover all your personal contributions within 36 months from the first plan distribution, then you will use the “General Rule” for determining the taxable portion of your distributions, Becourtney said.

The calculation can be made using the General Rule Method Worksheet found in Bulletin GIT-1, Pensions and Annuities, found on the New Jersey Division of Taxation website.

Becourtney said similar calculations are made when it comes to distributions from other types of retirement plans including distributions from 401(k), 403(b), Keogh, SEP and SIMPLE plans.

“If a plan was `noncontributory,’ meaning there were no employee contributions, then distributions are fully taxable for New Jersey purposes,” he said.

And remember, if your total gross income including taxable retirement distribution income does not exceed $100,000, then you qualify to claim a pension exclusion for New Jersey.

Becourtney said the pension exclusion will be increasing over the next four tax years based on legislation enacted last fall.

“For 2017 the pension exclusion doubles to $40,000 for a joint filer, to $30,000 if single or head of household and to $20,000 if married filing separate,” he said. “The taxpayer must have attained age 62 by the last day of the year in order to claim a pension exclusion.”

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NJMoneyHelp.com presents certain general financial planning principles and advice, but should never be viewed as a substitute for obtaining advice from a personal professional advisor who understands your unique individual circumstances.