Q. New Jersey’s pension exclusion is unfair. If you earn $1 over the maximum of $100,000, you get no benefit. What investments are tax-free for state and federal purposes and are recommended to reduce income for tax purposes? Bond values can vary, so are there any investments that will never go down yet provide a fair return?
A. Unfair? Of course everyone wants whatever tax breaks they can get, so we understand your frustration. But most tax breaks have some kind of cutoff. The pension exclusion is no different.
Let’s first go over the rules for the pension exclusion.
New Jersey allows seniors who are 62 or older to exclude all or part of their pension income plus other income from their state income tax return as long as your gross income is not more than $100,000.
This exclusion is going up between 2017 and 2020, when it reaches $100,000, said Bernie Kiely, a certified financial planner and certified public accountant with Kiely Capital Management in Morristown.
And you’re correct, he said. If your income is one dollar more than $100,000 you get zero pension exclusion. It is not phased out – it is simply gone.
Kiely said the instructions for calculating the pension exclusion state that the $100,000 limit is based on Line 26, Total Income.
So what income is not included on Line 26?
“There are three types of income that doesn’t show up: Social Security benefits, New Jersey municipal bond interest and federal government bond interest,” Kiely said. “Pretty much everything else is included as income on your New Jersey tax return.”
Now to your investment options.
Interest rates on almost all fixed income instruments are in flux, Kiely said.
“After years of historically low interest rates the Federal Reserve is allowing interest rates to slowly rise to a more realistic level,” he said. “The downside of higher interest rates is that existing bonds do not look as attractive as newer higher paying interest rates.”
Consequently, he said, if you want to get out of your bond before maturity you may have to sell it for less than its face value.
“One way to avoid this problem is hold all bonds until they mature,” he said. “At maturity the issuer will pay you the face value for the bond.”
Kiely said United States savings bond interest is taxed by the IRS but not by New Jersey.
“If you purchased five-year savings bonds through Treasury Direct, you will earn interest that will not be counted by New Jersey for purposes of the pension exclusion,” he said.
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