Understanding the New Jersey Retirement Income Tax Exclusion   

New Jersey has long provided state income tax exclusions for pensions and other retirement income. The state doesn’t tax Social Security benefits at all, and even provides a special exclusion for taxpayers aged 62 and up who are not eligible for Social Security or Railroad Retirement benefits.

While most pensions, annuities, and other retirement benefits are taxable, the state provides a retirement income tax exclusion which allows certain individuals and couples to exclude part or all of their retirement income when calculating state taxes. To qualify for the exclusion, the taxpayer must:

• Be age 62 or older, or be considered disabled under Social Security guidelines; and
• Have a gross household income of no more than $100,000

The exclusion has long been capped at $20,000 for married couples or those in civil unions who filed jointly, with lower limits for individuals or married people filing separately. However, a law enacted in 2016 will steadily raise the available exclusion over the next few years, starting with the 2017 tax year.

On the 2017 New Jersey tax return, married couples and those in civil unions who file jointly will be able to exclude up to $40,000 in retirement income—provided the conditions above are met. For single people, the limit is $30,000, and for married people filing separately, the exclusion is capped at $20,000 (half of the joint cap).

Over the next three years, the exclusion will continue to grow as follows:

It’s important to note, however, that while the exclusion cap is rising steadily across this four-year period, the cap for claiming the exclusion is not. While an eligible married couple with gross income of $100,000 will be able to exclude all of that income from state taxation in 2020—assuming that all of the income is qualifying retirement income—a couple with $100,001 in gross income will not qualify for the exclusion at all.

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Retirement Income Tax Exclusion When Only One Spouse Qualifies

In order to claim the retirement income tax exclusion, a taxpayer must be 62 or older or disabled. If both spouses meet those qualifications, the application of the exclusion is straightforward. But, if only one spouse qualifies, the cap may be more limited than the taxpayer anticipates.

For example, if one spouse is 65 years of age and the other is 61 and able-bodied, then only the older spouse will qualify for the exclusion. Assuming that the couple’s gross income is $100,000 or less and they otherwise qualify for the exclusion, only retirement income attributable to the older, qualifying spouse will be excludable. Thus, if the 65-year-old spouse receives $15,000 in retirement income and the 60-year-old spouse receives $50,000 in retirement income, the exclusion will be limited to the older spouse’s $15,000. Although the household is under the $100,000 cap and all of the household income is retirement income, the younger spouse’s retirement income may not be excluded.

Tax Planning for Retired Couples and Individuals

As the retirement income tax exclusion increases, it will become increasingly important for New Jersey retirees to consider the value of the exclusion in planning retirement account withdrawals, annuity purchases, and other income and disbursements. In some cases, where income is near the $100,000 cut-off and wholly or largely comprised of qualifying retirement income, retirees may find it worthwhile to schedule disbursements and manage investments in a manner that preserves access to the exclusion.

When it comes to protecting your family’s income and assets for the long term, tax planning can be as important as asset protection and estate planning. Talking with a New Jersey tax professional early in the year can help retirees prepare to maximize their exclusions for the current tax year and beyond.