02 Jan Does my IRA income count for the pension exclusion?

Q. I have a pension of $22,800. Assuming that I meet eligibility requirements for the pension exclusion, can I apply up to $38,200 of IRA distributions to the $60,000 on excludable retirement income on my 2019 taxes? I file my taxes as a single.
— Retired

A. Let’s go over how the pension exclusion works.

New Jersey allows those age 62 or older to exclude all or part of their pension income plus other kinds of income from their state income tax return.

In 2019, a qualified taxpayer with a filing status of single would be able to exclude up to $60,000 — it’s $80,000 for those married filing jointly — in pension income plus other income, said Giovanni Valle, a certified financial planner with Beacon Trust in Morristown.

The amounts will increase in 2020 to $75,000 for singles and $100,000 for those married filing jointly.

Valle said it’s important to first understand what the qualifications are for this exclusion.

“You qualify for the pension exclusion if you — and/or your spouse/civil union partner, if filing jointly — were 62 or older or disabled as defined by Social Security guidelines on the last day of the tax year, and if your total income for the entire year, which is on line 27 of the NJ-1040 Resident income tax return, is $100,000 or less,” Valle said. “It’s important to note that if your income is more than $100,000, you completely lose the ability to exclude any of the pension income.”

Moreover, the total income that is on line 27 does not include Social Security benefits, New Jersey municipal bond interest or federal government bond interest because these are all non-taxable in New Jersey, he said.

The $60,000 exclusion is based on your taxable pension and other income amount on line 20a, Form NJ-1040, Valle said.

“Generally speaking, the IRA distribution would be applied/counted towards the $60,000 limit on excludable retirement income,” he said.

But there are a few considerations.

First, you need to determine whether the full amount of your pension is considered taxable, and will therefore be reported on line 20a of the New Jersey tax return, he said.

Next, New Jersey does not generally tax the contribution portion of your IRA distributions.

“Contrary to the federal tax law, New Jersey does not allow you to deduct your IRA contributions during your lifetime,” he said. “This means that the money you used to contribute towards your IRA is being taxed on a state level as you contribute, which allows you to withdraw that portion on a tax-free basis at the state level.”

However, Valle said, the investment earnings portion of your IRA distribution will be taxable because earnings generated over time were never taxed.

“This is significant because if a portion of your IRA distribution is not taxable, it may affect the overall amount that can be withdrawn and still be excluded from your income,” he said.

Furthermore, certain quirks can occur if the IRA was a rollover from a qualified retirement plan, such as a 401(k), he said.

“This is because on or after Jan. 1, 1984, all 401(k) contributions are not included in your taxable income in New Jersey,” he said. “Therefore, distributions of these amounts would be entirely taxable and can be put on line 20a, and therefore can be applied/counted towards the $60,000 exclusion from income for the 2019 tax year.”

If, however, you contributed towards a 401(k) before 1984 and rolled over this 401(k) plan to your IRA, a portion of that amount may not be taxable when withdrawn because contributions towards the 401(k) would have been included in New Jersey taxable income, he said.

If some of the considerations mentioned apply to you, a tax professional would be able to help guide you and make sure that you are maximizing your exclusion if you qualify.

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This story was originally published Jan. 2, 2020.

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.