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Politicians consider changing 401(k) tax

MONTGOMERY (AP) — Alabama doesn’t levy any state income tax on traditional pensions, but it does tax 401(k)s and other defined contribution retirement plans.

State officials agree that’s an inequity in Alabama’s tax system, but they disagree about how to address it.

Gov. Bob Riley proposed a tax break for 401(k)s in the last session of the Legislature, but it went nowhere because it would reduce income taxes that fund public schools and colleges.

Alabamians now collect about $3.5 billion a year from government and corporate pensions, and the state taxes none of it, said state Revenue Commissioner Tom Surtees.

If the state taxed it all, retirees collecting pensions would pay about $172 million a year more in income taxes, the state Revenue Department estimates.

Alabamians also collect about $2 billion a year from 401(k)s, individual retirement accounts, and other taxable defined-contribution plans, Surtees said.

People pay about $100 million a year in state income taxes on money they collect from those plans, the department estimates.

The state’s maximum income tax rate is 5 percent.

Retirement

Defined benefit retirement plans, where a retiree receives a set annual payment based on their working income and years of service, have been free of state income taxes since the early 1990s.

That includes the state pensions received by retired state workers and education employees.

In recent years, many companies have begun phasing out their traditional pension plans and offering their employees 401(k)s instead.

With these plans, the employee — and sometimes the employer — makes a defined contribution for investment, but there is no guaranteed benefit. That depends on how the investments perform.

Riley said it would be “too big a hit” for the state to lose $100 million a year in income-tax collections by exempting all income from 401(k)s and other defined contribution plans.

Copyright 2005 Associated Press. All rights reserved. This material may not be published, broadcast, rewritten or redistributed.

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