IRA Distributions: Federal VS NJ
Contributing to a traditional IRA reduces your federal income and, as a result, when you take a distribution down the road it’s fully taxable. While the distribution is fully taxed on the federal level because of this previous tax benefit, what many overlook is the fact that the distribution is not necessarily fully taxable to New Jersey. When the contributions to the traditional IRA were made, they were not deductible for NJ.
Want To Give Christie a Gift?
As a result, unless you would like to give Governor Christie some extra cash there is no reason to pay NJ tax on the return of your original contributions. Let’s illustrate this with an example. Suppose John contributed $5,000 a year to his IRA for 5 years (a total of $25,000). Many years pass, and he decides to take a distribution, when his IRA account has grown to $100,000. The entire balance is subject to federal income tax. The State of New Jersey, however, only requires that tax be paid on the amount exceeding the $25,000 contributed. Taxpayers who unknowingly pay state tax on the entire distribution will never see that money again unless they amend. Their only consolation would be that they’ve helped chip away at the state budget deficit.
To Whom Does This Pertain?
Some of the most common types of accounts that this difference applies to are: traditional IRAs, KEOGH plans, and 403(b) plans. The contributions to all of these accounts are deducted on the federal level but not on the NJ state level, resulting in NJ state tax savings when taking a distribution.
Three Times in Life When This Would Become Relevant
There are three common scenarios in which this rule would affect a taxpayer. The first is if the taxpayer has reached retirement and begins taking distributions from his traditional IRA. A second scenario would be if one makes a conversion from a traditional IRA to a Roth IRA (when one converts to a Roth IRA the entire account is taxed on the federal level). A third occasion would be if a taxpayer were to fall on hard times and decides to prematurely withdraw from his traditional IRA. Before you file your 2011 income taxes, make sure that you are not overpaying your NJ income taxes.
Be Sure To Maintain Records
Often IRAs are transferred through many financial institutions over the years and it can be difficult to determine the portion attributable to your contributions (as opposed to growth of the funds contributed). The key to keeping NJ’s claws off your money is to maintain a record of the portion contributed to your traditional IRA accounts, Keogh plans and 403(b) plans.