Current Pension Topics
403(b) Taxable in New Jersey

By JOEL L. FRANK

Q.: My wife and I are residents of New Jersey and have been contributing to a 403(b) for years. I work for the Health and Hospitals Corporation, while my wife works for the Department of Education. I have my 403(b) through Prudential and she contributes to the 403(b) of the Teachers' Retirement System. The New Jersey Division of Taxation has informed us that we owe income tax on the 403(b) contributions we made in 2004. They have assessed interest and penalty fees on top of the tax that is owed. My Certified Public Accountant (CPA) was not aware of this regulation. Are the New Jersey officials correct?

P.A.

A.: You bet they are. The 401(k) is the only pre-tax plan that is tax-deferred in New Jersey. Contributions to a 403(b) and 457(b) account are fully taxable by New Jersey in the year the contribution is made. I would get a new CPA inasmuch as the instruction booklet for the preparation of New Jersey Resident Return publishes a list of 20 items of taxable income. Item 20 states: "Employee contributions to Federal Thrift Savings Funds, 403(b), 457, SEP or any other type of retirement plan other than 401(k) Plans."

Advice: Stop all contributions to the 403(b) plans you currently contribute to. As city employees, use the Deferred Compensation 401(k) Plan of the City of New York for pre-tax investing. Result: You and your wife have eliminated two inferior 403(b) plans from your life and gained a superior 401(k) plan. You now know for certain that your contributions to the city's 401(k) Plan are not taxable in New Jersey. Invest in the appropriate Pre-Arranged Portfolio offered by the 401(k) Plan.

Having said that, I would write a letter to your state representatives in the New Jersey Senate and Assembly demanding parity with those who contribute to 401(k) plans.

You may also want to write a letter of concern to the New Jersey Education Association, which purports to represent the best interests of New Jersey's public school personnel, and "remind" them that the K-12 crowd is not allowed to contribute to 401(k) Plans but has been using 403(b) plans, in droves, instead for almost 50 years (as if they do not know this). The New Jersey Education Association should make sure the current legislative session addresses this severe injustice that has been perpetrated on their dues-paying members for nearly half a century.

I recently got a call from a person who was advising a cop to not only contribute his certified rate to the Police Pension Fund but also to put as much additional money as he could afford into the Pension Fund and not contribute to the city's 457 Plan at all. The rationale given for this advice was the 8.25-percent guaranteed interest paid by the Pension Fund.

The "advisor" asked me if I agreed with his advice. I told this person I most certainly do not agree. One must factor into the analysis more than just the handsome 8.25-percent guaranteed return of the Pension Fund. The certified rate of contribution while being tax deferred on the Federal level under Section 414(h) of the Internal Revenue Code is fully taxable on the state and city level.

Additionally, all contributions to the Pension Fund in excess of the certified rate are fully taxable on the Federal, state and city levels. On the other hand, every dollar contributed to the 457(b) and 401(k) Deferred Compensation Plans of the City of New York is tax deferred on the Federal, state and city levels.

While the Deferred Compensation Plans' Stable Value Fund does not currently generate returns approaching 8.25 percent, its return will continue to go up and down as interest rates in the economy go up and down.

Over the long term, the stock market has returned about 10 percent annually. It is my belief that members of the Police and Fire Pension Funds will be serving their long-term interests better by contributing nothing to the their respective Pension Fund while contributing all they can to the appropriate Pre-Arranged Portfolio of the 457 and 401(k) Deferred Compensation Plans of the City of New York.

Mr. Frank is a fee-only Retirement Financial Planner. He can be reached by telephone at (732) 536-9472, or via e-mail at rollover@optonline.net .