It appears likely that your pension is excluded from NJ taxable income. Admittedly, the topic is a bit complicated because of how New Jersey has written the law. As far as the options that you refer to, note the following excerpt from the following website: http://www.state.nj.us/treasury/taxation/njit6.shtml (You may click on the link for full information):
Contributory Plans (Other Than IRAs)
If you were required to contribute to your retirement plan, it is a contributory plan. Contributions are usually made through payroll deductions, and, in general, have already been taxed. Your contributions are not taxed when withdrawn. However, any employer contributions and earnings that have not been taxed must be reported.
You will need to determine the taxable and excludable parts of your distribution. There are two methods you can use to calculate these amounts: Three-Year Rule Method and General Rule Method. If you use the Three-year Rule Method, your pension is not reported as taxable income until the payments you receive from the plan equal the amount you contributed. Once you have received an amount equal to your contributions, all payments from the pension plan are fully taxable. If you use the General Rule Method, part of your pension or annuity payment is taxable and part is excluded from your income every year. If you are filing a resident return, you must report both the taxable and excludable portions of your distribution on the separate lines provided for that purpose on Form NJ-1040. (Italics and bolding added).
You will be glad to know that you do not need to worry about that rule at all, however. New Jersey has a different exclusion for your income because of your age. Please note the following website link (Click on link for more information): http://www.state.nj.us/treasury/taxation/njit7.shtml. According to that site, up to 30,000 of your pension income is excluded from taxable income as long as your total income does not exceed $100,000. And the amount goes up in future years. Since you appear to be drawing far less than that figure yearly, it is very likely that your pension is completely excluded and you do not need to answer the questions regarding the source of your pension.
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