13 Feb How do I figure the tax on my retirement account distribution?

Q. I have a 457 plan and I took my first distribution this year. My employer did not contribute so I need to use the General Rule Method to determine the taxable amount. I know my total contributions, but it isn’t clear how I should calculate the “Expected return on contract” since this 457 plan is not an annuity, but a set of investments. Do I need to calculate a return (e.g. 4%) for each year on the amount left after withdrawals and total the sums up?
— Retired now

A. Great question.

You don’t want to mess up the calculation.

A 457 plan is a tax advantaged retirement plan offered to some government employees, said Bernie Kiely, a certified financial planner and certified public accountant with Kiely Capital Management in Morristown.

“When an employee or employer contributes to a 457 plan, it is a tax-deferred basis for federal income tax purposes,” he said. “When the employee takes funds out of a 457 plan, the entire distribution is subject to federal income taxes — similar to a regular IRA.”

This is because all funds that went into the plan were on a pre-tax basis, he said.

But New Jersey doesn’t recognize 457 plans for income tax purposes.

“This means that every time an employee makes a contribution to the plan, it’s before tax for federal purposes but it’s after tax for New Jersey income tax purposes,” he said.

For example, if a person earns $20,000 per year and contributes 10% ($2,000) to their 457 plan, their W-2 form says $18,000 taxable income for federal purposes but, it says $20,000 for state purposes. The worker pays federal tax on $18,000 and New Jersey tax on all $20,000, Kiely said.

Because the contributions to a 457 plan are pre tax for federal purposes, the participant has no tax basis in the plan, Kiely said.

“Tax basis is IRS speak for tax cost,” he said. “Since they have no basis, every penny withdrawn is subject to federal income tax. For New Jersey purposes, you do have tax basis since the participant made after tax contributions.”

New Jersey has two rules concerning tax basis on 457 withdrawals.

The first rule is the Three Year Rule, Kiely said. If in the first three years of withdrawals you will take out an amount equal or greater than your tax basis, you pay no tax until the cost basis is recovered. After that all withdrawals are subject to state tax, he said.

If you will not withdraw your tax basis within the first three years The General Rule applies.

The New Jersey Tax Department has a worksheet you can use to calculate the taxable portion of a 457 plan withdrawal, he said. This worksheet requires you to estimate the future return of the plan.

Kiely said in his experience, many people become confused about this requirement.

“I often tell people to write down the total unrecovered cost basis in the plan and the current market value,” he said. “If you divide the cost basis by the current market value, you arrive at a percentage.”

He gave an example. Let’s assume that percentage is 25%. If you withdraw $10,000 from the plan, $2,500 is cost basis and $7,500 is taxable. You subtract the $2,500 cost basis from the running total. Next year, you write down the new unrecovered cost basis and next year’s market value which results in a percentage. New Jersey will have no problem with this method, he said.

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This story was originally published in February 2026. 

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