If a retired NYC teacher rolls 403(b) tax-deferred annuity funds into a private IRA, are later distributions from that IRA exempt from New York personal income tax?

Plain-English summary

Richard Epstein retired on July 1, 2003, at age 56, from the Board of Education of the City of New York, where he had been a Tier 1 pension member. While working there, he contributed to the New York City Teachers' Retirement System's IRC 403(b) tax-deferred annuity plan. After retiring, he rolled the funds from that 403(b) plan over into a private IRA, and he asked the Department whether distributions from that IRA would be exempt from New York personal income tax, and if so, how to figure out which part of each distribution was exempt.

The Department first noted that distributions taken directly from the 403(b) plan itself - the NYC Teachers' Retirement System's tax-deferred annuity program, authorized by Education Law § 3109-A and maintained under NYC Administrative Code § 13-582 - are exempt from New York State and New York City personal income tax under NYC Administrative Code § 13-561, which broadly exempts Teachers' Retirement System benefits from state and municipal tax. That exemption had already been confirmed for direct 403(b) distributions in a prior advisory opinion, Robert Weitzman, TSB-A-02(9)I.

But once the money moves into a private IRA, the analysis shifts. Relying on an older ruling, Joseph W. Martiney, TSB-H-80-(523)I, the Department held that only the part of an IRA distribution that represents a return of the pension funds originally rolled over is a nontaxable return of principal; any interest or other gain earned inside the IRA is taxable. Applying that rule to Epstein, the Department concluded that regardless of his age at the time of distribution, the portion of each IRA distribution attributable to the rolled-over 403(b) contributions remains exempt under § 13-561 and is subtracted from federal adjusted gross income in computing his New York adjusted gross income - but the remaining portion (interest and other gain) is taxable.

The Department also addressed how to split a distribution between the two categories: divide the amount of 403(b) contributions rolled into the IRA by the IRA's total value (including the amount being distributed) as of the distribution date, then multiply that fraction by the amount distributed. This calculation - which parallels the method in IRS Notice 87-16 for recovering nondeductible IRA contributions - is repeated for the initial distribution year and every year after until all of the nontaxable rolled-over contributions have been recovered. Once Epstein turns 59½, the taxable (interest/gain) portion of his distributions may also qualify, together with any other qualifying pension and annuity income, for the $20,000 exclusion under Tax Law § 612(c)(3-a).

What this means for you

If you rolled a 403(b) or pension into a private IRA

Don't assume the whole IRA is tax-free just because it traces back to a tax-exempt government or Teachers' Retirement System plan. Once pension or 403(b) funds are commingled in a private IRA, only the portion of each distribution that represents a return of the original rolled-over contributions stays exempt; interest and other gain earned inside the IRA becomes taxable, subject to whatever exclusions otherwise apply (such as the $20,000 pension and annuity exclusion at age 59½).

If you're calculating the exempt portion each year

Use the pro-rata formula: (rolled-over contributions still in the IRA) ÷ (total IRA value, including the current distribution) × (amount distributed) = the nontaxable, return-of-principal portion for that year. Recompute this every year a distribution is taken until the entire rolled-over contribution amount has been recovered tax-free; everything else is potentially taxable income.

Common questions

Q: Are distributions from an IRA automatically exempt just because the money originally came from a tax-exempt 403(b) or government pension plan?
A: No. The exemption under NYC Administrative Code § 13-561 follows the contributions, not the account. Once rolled into a private IRA, only the portion of a distribution that returns those original contributions stays exempt; interest and other gain earned in the IRA is taxable.

Q: How do you figure out how much of a distribution is exempt?
A: Divide the rolled-over 403(b) contributions by the IRA's total value (including the distribution) at the date of distribution, and multiply that fraction by the amount distributed. That fraction is the nontaxable return-of-principal portion; the rest is potentially taxable.

Q: Does the taxpayer's age matter for this calculation?
A: Not for recovering the rolled-over contributions - that recovery is exempt under § 13-561 regardless of age. Age matters separately for the taxable interest/gain portion, which can qualify for the $20,000 pension and annuity exclusion under Tax Law § 612(c)(3-a) only once the individual reaches age 59½.

Q: Is the pro-rata calculation done once, or repeated?
A: It's repeated for the initial distribution year and each subsequent year until the full amount of the rolled-over, nontaxable contributions has been recovered.

Q: Does this ruling rely on any prior New York advisory opinions?
A: Yes - it follows Robert Weitzman, TSB-A-02(9)I (direct 403(b) distributions from the NYC Teachers' Retirement System are exempt under § 13-561) and Joseph W. Martiney, TSB-H-80-(523)I (rollover IRA distributions are nontaxable only to the extent they return the rolled-over pension principal).

Citations and references

• Tax Law § 612(a) - defines New York adjusted gross income
• Tax Law § 612(c)(3) - subtraction for pensions of New York state and local government officers and employees
• Tax Law § 612(c)(3-a) - up to $20,000 exclusion for pensions and annuities once the recipient reaches age 59½
• 20 NYCRR 112.3(c)(2)(ii) - IRA and Keogh distributions qualify for the pension and annuity income modification, periodic or lump sum
• NYC Administrative Code § 13-561 - exempts NYC Teachers' Retirement System benefits from state and municipal tax
• NYC Administrative Code § 13-582 - establishes the NYC Teachers' Retirement System's tax-deferred annuity program
• Education Law § 3109-A - authorizes salary reduction agreements funding NYC teachers' tax-deferred annuities
• IRC § 403(b)(1) - federal tax-deferred annuity provisions for public school and 501(c)(3) employees
• Robert Weitzman, TSB-A-02(9)I (Dec. 16, 2002) - direct 403(b) distributions from the NYC Teachers' Retirement System are exempt
• Joseph W. Martiney, TSB-H-80-(523)I (Nov. 24, 1980) - rollover IRA distributions are nontaxable only as a return of rolled-over pension principal

Source

• Landing page: https://www.tax.ny.gov/pubs_and_bulls/advisory_opinions/income_ao_2003.htm
• Opinion: https://www.tax.ny.gov/pdf/advisory_opinions/income/a03_5i.pdf

Original ruling text

New York State Department of Taxation and Finance

Office of Tax Policy Analysis
Technical Services Division

TSB-A-03(5)I
Income Tax
November 19, 2003

STATE OF NEW YORK
COMMISSIONER OF TAXATION AND FINANCE
ADVISORY OPINION

PETITION NO. I030620A

On June 20, 2003, a Petition for Advisory Opinion was received from Richard Epstein, 1535
Kevin Place, East Meadow, New York 11554. Petitioner, Richard Epstein, provided additional
information pertaining to the Petition on July 23, 2003.
The issues raised by Petitioner are:

1. Whether distributions received from an Individual Retirement Account (IRA) established
   by means of a tax-free rollover or direct transfer of amounts received from an Internal
   Revenue Code (IRC) section 403(b) tax-deferred annuity plan (IRC 403(b) plan) are exempt
   from New York personal income tax.
2. If the answer to Issue 1. is yes, what method is used to distinguish the amount that
   represents a return of tax exempt pension funds rolled over into an IRA from interest or any
   other gain accrued.
   Petitioner submits the following facts as the basis for this Advisory Opinion.
   Petitioner retired on July 1, 2003, at the age of 56 from the Board of Education of the City
   of New York. Petitioner was a Tier 1 pension member. While working for the Board of Education
   of the City of New York, Petitioner contributed to his New York City Teachers’ Retirement IRC
   403(b) plan. After retiring, Petitioner rolled over funds from his New York City Teachers’
   Retirement IRC 403(b) plan into a private IRA.
   Applicable law and regulations
   IRC section 403(b)(1) contains employee annuity provisions for a beneficiary under an
   annuity purchased by a public school, and provides, in part:
   General rule. If ­
   (A) an annuity contract is purchased ­
   (i) for an employee by an employer described in section 501(c)(3) which is
   exempt from tax under section 501(a),

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(ii) for an employee (other than an employee described in clause (i)), who
performs services for an educational organization described in section
170(b)(1)(A)(ii), by an employer which is a State , a political subdivision of a State,
or an agency or instrumentality of any one or more of the foregoing...
*

*

*

(B) such annuity contract is not subject to subsection (a),
(C) the employee’s rights under the contract are nonforfeitable, except for failure to
pay future premiums,
*

*

*

and
(E) in the case of a contract purchased under a salary reduction agreement, the
contract meets the requirements of section 401(a)(30),
then contributions and other additions by such employer for such annuity contract shall be
excluded from the gross income of the employee for the taxable year to the extent that the
aggregate of such contributions and additions (when expressed as an annual addition (within
the meaning of section 415(c)(2))) does not exceed the applicable limit under section 415.
The amount actually distributed to any distributee under such contract shall be taxable to the
distributee (in the year in which so distributed) under section 72 (relating to annuities)....
Section 3109-A of the Education Law authorizes the reduction of salaries of teachers in
New York City school districts for the purpose of purchasing tax deferred annuities. The tax
deferred annuity program of the New York City Teachers’ Retirement System, which implements
this provision, is set forth in section 13-582 of the Administrative Code of the City of New York
(New York Administrative Code).
Section 13-582.a of the New York Administrative Code provides that “Any member for
whom a salary reduction agreement is executed pursuant to . . . section three thousand one hundred
nine-A of the education law shall thereby become a participant in the tax-deferred annuity
program....”
Section 13-582.f of the New York Administrative Code adopts the provisions of section
13-561 of the New York Administrative Code by reference, and provides that as such section applies
“to the contributions made by a contributor and the benefits provided thereby, shall apply separately

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and independently to the tax-deferred annuity net contributions and the benefits provided thereby....”
Section 13-561 of the New York Administrative Code, as amended by Chapter 248 of the
Laws of 1994, (formerly section B20-48.0 as enacted by Chapter 929 of the Laws of 1937) provides
a general state and local income tax exemption for payments made under the New York City
Teachers’ Retirement System, and provides, in part:
Exemption from tax, execution, etc. The right of a person to a pension, a pension­
providing-for-increased-take-home-pay, an annuity, or a retirement allowance, to the return
of contributions, the pension, pension-providing-for-increased-take-home-pay, annuity, or
retirement allowance itself, any optional benefit, any other right accrued or accruing to any
person under the provisions of this chapter, and the moneys in the various funds provided
for by this chapter, are hereby exempt from any state or municipal tax, and exempt from levy
and sale, garnishment, attachment or any other process whatsoever, and shall be
unassignable except as in this chapter specifically otherwise provided....
Section 612(a) of the Tax Law provides:
General. The New York adjusted gross income of a resident individual means his
federal adjusted gross income as defined in the laws of the United States for the taxable year,
with the modifications specified in this section.
Section 612(c) of the Tax Law provides, in part:
Modifications reducing federal adjusted gross income. There shall be subtracted
from federal adjusted gross income:
*

*

*

(3)(i) Pensions to officers and employees of this state, its subdivisions and agencies,
to the extent includible in gross income for federal income tax purposes;
*

*

*

(3-a) Pensions and annuities received by an individual who has attained the age of
fifty-nine and one-half, not otherwise excluded pursuant to paragraph three of this
subsection, to the extent includible in gross income for federal income tax purposes, but not
in excess of twenty thousand dollars, which are periodic payments attributable to personal
services performed by such individual prior to his retirement from employment, which arise
(i) from an employer-employee relationship or (ii) from contributions to a retirement plan
which are deductible for federal income tax purposes. However, the term "pensions and

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annuities" shall also include distributions received by an individual who has attained the age
of fifty-nine and one-half from an individual retirement account or an individual retirement
annuity, as defined in section four hundred eight of the internal revenue code, and
distributions received by an individual who has attained the age of fifty-nine and one-half
from self-employed individual and owner-employee retirement plans which qualify under
section four hundred one of the internal revenue code, whether or not the payments are
periodic in nature. Nevertheless, the term "pensions and annuities" shall not include any
lump sum distribution, as defined in subparagraph (A) of paragraph four of subsection (e)
of section four hundred two of the internal revenue code and taxed under section six hundred
three of this article. Where a husband and wife file a joint state personal income tax return,
the modification provided for in this paragraph shall be computed as if they were filing
separate state personal income tax returns. Where a payment would otherwise come within
the meaning of the term "pensions and annuities" as set forth in this paragraph, except that
such individual is deceased, such payment shall, nevertheless, be treated as a pension or
annuity for purposes of this paragraph if such payment is received by such individual's
beneficiary.
Section 112.3(c)(2)(ii) of the New York State Personal Income Tax Regulations provides,
in part:
Distributions from an individual retirement account (IRA) or a self-employed
retirement plan (Keogh) will qualify for the pension and annuity income modification
whether such distributions are periodic payments or a lump sum distribution....
Opinion
Pursuant to section 3109-A of the Education Law, a person employed by the Board of
Education of the City of New York may agree to reduce his or her annual salary and become a
participant in a tax deferred annuity program. The New York City Teachers’ Retirement System
tax deferred annuity program is authorized by IRC section 403(b), and is maintained pursuant to
section 13-582 of the New York Administrative Code. Distributions from the IRC 403(b) plan
maintained pursuant to section 13-582 of the New York Administrative Code are exempt from New
York State and New York City personal income taxes pursuant to section 13-561 of the New York
Administrative Code.
Article 16, section 5 of the New York State Constitution provides that "all salaries, wages
and other compensation, except pensions, paid to officers and employees of the state and its
subdivisions and agencies shall be subject to taxation."
In Robert Weitzman, Adv Op Comm T&F, December 16, 2002, TSB-A-02(9)I, it was held
that distributions received by the petitioner from his New York City Teachers’ Retirement IRC

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403(b) plan are exempt from New York State personal income tax pursuant to section 13-561 of the
New York Administrative Code.
In Joseph W. Martiney, Adv Op St Tax Commn, November 24, 1980, TSB-H-80-(523)I, it
was held that the distributions from an IRA established by means of a tax-free rollover of amounts
received in the form of a pension from New York State or a subdivision or agency thereof,
represents a nontaxable return of principal to the extent that the distribution represents a return of
the pension funds "rolled over" into the IRA. To the extent that the distribution represents interest,
or any other type of gain earned in the account, such portion would be subject to tax.
In accordance with Martiney, supra, when Petitioner receives distributions from the rollover
IRA account, only a portion of the distribution is exempt. Regardless of Petitioner’s age at the time
of distribution, assuming the distributions Petitioner receives from the rollover IRA account are
included in his federal adjusted gross income, the portion of a distribution from the rollover IRA
account that represents the amount of the IRC 403(b) plan that was rolled over into the IRA (the
contribution) is a return of the IRC 403(b) plan contribution and is exempt for New York State
purposes pursuant to section 13-561 of the New York Administrative Code. Such portion of the IRA
distribution would be subtracted from federal adjusted gross income when computing Petitioner's
New York adjusted gross income for the taxable year.
Assuming that a distribution during the taxable year is a partial distribution of an IRA
established by means of a tax-free rollover or direct transfer of amounts received from Petitioner’s
IRC 403(b) plan, to determine the amount of distribution that represents a return of nontaxable
funds, divide the amount of contributions rolled over from the IRC 403(b) plan to the IRA by the
total value of the IRA, including the amount of distribution, at the date of distribution and multiply
the result by the amount distributed. This computation is used for the initial year that a distribution
is made and each succeeding year until the total amount of nontaxable contributions is recovered.
This method essentially parallels the method prescribed in Internal Revenue Service Notice 87-16,
1987-1 CB 446, for determination of the portion of a distribution from an IRA that is attributable
to the return of nondeductible contributions.
In addition, section 612(c)(3-a) of the Tax Law and section 112.3(c)(2) of the Personal
Income Tax Regulations provide that the balance of the distribution from the rollover IRA account
that represents any other amount in the rollover IRA account, including any other contributions or
interest or any other type of gain or income earned, may not be subject to tax. When Petitioner
reaches the age of 59 ½ years, such amount may be added to Petitioner’s other pension and annuity
income, if any, that meets the conditions of section 612(c)(3-a) of the Tax Law and section
112.3(c)(2) of the Personal Income Tax Regulations for purposes of computing the $20,000 pension
and annuity income modification. The total, but not in excess of $20,000, would be allowed as
a subtraction from federal adjusted gross income when computing Petitioner's New York adjusted

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gross income. Any excess would be subject to tax and would not be allowed as a subtraction from
federal adjusted gross income when computing Petitioner's New York adjusted gross income.

DATED: November 19, 2003

NOTE:

/s/
Jonathan Pessen
Tax Regulations Specialist IV
Technical Services Division

The opinions expressed in Advisory Opinions are
limited to the facts set forth therein.