27 Mar Does Social Security income count for the pension exclusion?

Q. For the pension exclusion, the instructions make it sound like there are very few exceptions for excluding types of income. Yet in the FAQ section on the web site when someone asks what pension amount they report, the answer is, “You must report taxable amount of pension and annuity payments.” Does this also mean for Social Security payments which are not taxable in New Jersey?
— Uncertain

A. It’s a good question.

Here is how the pension exclusion works.

New Jersey extends a limited pension and retirement income exclusion to taxpayers with gross income exceeding $100,000 but not more than $150,000, said Matthew DeFelice, a certified financial planner with U.S. Financial Services in Fairfield.

Social Security is not taxed at the state level in New Jersey, he said.

For the pension exclusion, retirement income includes pensions, annuity payments, 401(k) and 403(b) plans and IRA withdrawals, DeFelice said.

And if a taxpayer cannot use their maximum pension exclusion amount and if their earned income from wages proprietorships, partnerships and S corporations totals $3,000 or less, the unclaimed pension exclusion can be used to exclude other types of income such as wages, interest, dividends, and more from taxes, he said.

As of June 2021, taxpayers who are 62 years of age or older, or taxpayers eligible for disability payments under the federal Social Security Act, are eligible based on their income levels and filing status.

If your total income is $100,000 or less, you can exclude reported taxable pension, annuity, and IRA withdrawals up to the maximum amount for your filing status, which is married filing jointly at $100,000, married filing separately $50,000 and single/head of household/qualifying widow(er) at $75,000, he said.

If your total income is $100,001, but not more than $125,000, you can exclude a percentage of your reported taxable pension, annuity, and IRA withdrawals based on your filing status: married filing jointly at 50%, married filing separately at 25% and single/head of household/qualifying widow(er) at 37.5%.

Those whose income are $125,001 but not more than $150,000 can exclude a percentage of your reported taxable pension, annuity, and IRA withdrawals based on your filing status at the levels of married filing jointly at 25%, married filing separately at 12.5% and single/head of household/qualifying widow(er) at 18.75%.

“There is a cliff effect, however, meaning that a taxpayer with gross income of $150,001 or more will lose their entire exclusion,” DeFelice said.

As far as New Jersey is concerned, the total income limits exclude Social Security benefits, New Jersey municipal bond interest and federal government bond interest, DeFelice said.

“Therefore, some strategies that may make sense from a tax-savings perspective if you believe you will be close to the exclusion amounts include adjusting your investment allocation to include investments not subject to New Jersey income taxes, limit investments that generate sizable dividends and capital gains, and minimize withdrawals from retirement accounts if possible,” DeFelice said.

He recommends before you change any investment allocation strategy, you should speak with a qualified professional who has core competencies in retirement income and distribution planning before making any decisions.

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This story was originally published on March 27, 2023.

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.