HOW ARE MY PENSION BENEFITS TAXED FOR FEDERAL PURPOSES?
Pension benefits (except for Accidental Disability retirement and Accidental Death benefits) are subject to federal income tax; however, if you paid tax on any of your contributions to the pension plan, that portion of your monthly benefits representing a return of your previously-taxed contributions is not taxable. Contributions made to the pension plan prior to January 1, 1987 were already taxed as were any purchases of optional pension membership credit made before 2002. After January 1, 2002 some purchases may have been made with previously-taxed money. Therefore, if you began contributing to the pension plan prior to January 1, 1987, or if you purchased pension membership since then, all or a portion of your total contributions may have been previously subject to federal tax.
The rate at which you can recover your previously taxed contributions is determined in part by your retirement date.
If you retired before August 1, 1986 —
you were able to fully recover your contributions before having to pay tax on your benefits. Once you recovered your contributions, your benefits became fully taxable. The exception is if you did not fully recover your contributions within the first three years of retirement. In that case, you had to recover your contributions under the IRS expected return rule explained below.
If you retired on or after August 1, 1986 —
You must recover your contributions under the expected return rule. Under this rule, you recover your contributions evenly over your expected lifetime or the combined lifetime of you and your pension beneficiary. This means that only a small portion of each monthly benefit is considered a return of your previously-taxed contributions and is tax-free.
CALCULATING THE NON-TAXABLE AMOUNT
If you retired after July 1, 1986 and before November 1, 1996 — your monthly nontaxable amount is determined using life expectancy tables found in IRS Publication 939.
If you retired on or after November 1, 1996 —
The following tables are used to determine your monthly nontaxable amount:
TABLE A
WITHHOLDING FEDERAL INCOME TAX FROM YOUR PENSION CHECK
Each new retiree will automatically receive a federal withholding tax Form W-4P near the date of retirement. The Division of Pensions and Benefits is required by federal law to automatically withhold federal income tax from your pension check, based on a status of married with three allowances if you do not complete a W-4P. The W-4P allows you to elect no withholding or, if you want withholding, to inform us of your tax filing status so that we can withhold the proper amount.
WITHHOLDING NJ STATE INCOME TAX FROM YOUR PENSION CHECK
If you live in New Jersey you will automatically receive a New Jersey State withholding tax Form NJ W-4P near the date of retirement. Most retirees will not be subject to New Jersey income tax until they recover in pension checks the amount of the contributions
which they made to the pension plan while working. If you will not recover your total contributions within three years of retirement, refer to the instructions for the Form NJ-1040 to determine how your pension is taxed. You can find information on both the three year rule and the general rule methods on the instructions for the Form NJ-1040.
If you are at least 62 or considered disabled by Social Security, you may exclude the following amounts of retirement income from New Jersey income tax for the tax year indicated below:
Note: Beginning with tax year 2005, the “Retirement Income Exclusions” listed above are limited to taxpayers with gross income of $100,000 or less. Please see the instructions for the Form NJ-1040 or contact the New Jersey Division of Taxation or a professional tax advisor for further information.
Unlike federal income tax, withholding for New Jersey income tax is completely voluntary. No New Jersey income tax will be withheld unless you authorize it by completing a Form NJ W-4P. The amount withheld must be at least $10.00 per month and in even dollar amounts (no cents). If you need help deciding whether or not to have New Jersey
income tax withheld or how much tax to have withheld, you can contact the New Jersey Division of Taxation at 1-800-323-4400.
QUESTIONS COMMONLY ASKED AFTER RETIREMENT
Will I receive a statement of pension income for tax purposes?
Yes. retirees receive Form 1099-R at the end of January each year, covering the previous tax year. This shows the gross retirement allowance; how much is subject to federal income tax; and the amounts, if any, that were withheld for federal and New Jersey income tax.
Am I taxed on the reimbursement of Medicare premiums?
No. Some State employees and all employees of boards of education or county colleges who retired with 25 or more years of service, or on a disability retirement, who are enrolled in the State Health Benefits Program are reimbursed in their pension checks for the Medicare Part B premiums they pay to Social Security. If you receive this Medicare reimbursement,
the gross amount of your pension checks will be greater than the gross amount shown
on your Form 1099-R because the Medicare reimbursement is not taxable. The Medicare premium reimbursement is subtracted from your total gross income to determine the gross pension reported to the IRS.
Why doesn’t my gross allowance equal 12 times the amount of my December 1 check?
When you receive a cost-of-living increase, your pension is changed each year with the February 1 check. Therefore, the gross allowance for your January 1 check is usually less than your next 11 checks.
Is my disability pension taxable?
If you are receiving a disability pension, your benefits are not subject to New Jersey income tax until you reach age 65. If you are receiving an Accidental Disability pension,— or if you are a survivor receiving Accidental Disability or Accidental Death benefits — the
Division of Pensions and Benefits reports your benefit as exempt from federal income tax.
Ordinary Disability pensions are subject to federal tax to the same extent as other pensions.
Source: http://www.state.nj.us/treasury/pensions/epbam/exhibits/factsheets/fact12.pdf