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Good question, and I don't know the answer but as a Californian I am also interested. Were did you see the article. You might also post this on the Folly in California board to see if anyone there can provide some insight.
Your assumption regarding paying CA taxes on the contribution which exceeds $10,500 is probably correct but it does sound like it would be a bookeeping nightmare to keep track of what is taxable and by whom at the time of withdrawal from the plan. Some plans will allow after federal tax contributions to them and when they are withdrawn no taxes are due but to keep track of the funds for state purposes also sounds very difficult.
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