Israeli Financial Instruments & Children’s Savings Accounts
By Nathan Savransky, CPA
U.S. taxpayers living in Israel face issues that are unique in their tax implications. Israeli companies provide their employees with a variety of deferred compensation arrangements, including keren hishtalmut (education funds), keren pensia (pension funds), and bituach menahalim (manager’s insurance). These financial instruments have special treatment under U.S. tax law and in most cases must be disclosed in information returns.
This article will discuss the most common Israeli employer-sponsored funds, their U.S. tax implications and some of the most frequently asked questions on the subject.
Keren hishtalmut funds allow Israeli employees to contribute 2.5% of their base salary (plus a 7.5% employer matching) to a tax-free fund which opens after six years. Once the fund opens, taxpayers can withdraw the funds at any time or continue to save tax-free. Unlike pensions, this benefit is not mandatory.
While exempt from Israeli tax, employer contributions and profits from keren hishtalmut are fully taxable in the U.S.
Keren Pensia funds accumulate tax-free until retirement age. Every Israeli employer is required to set up a pension for its employees. Upon retirement, taxpayers normally receive a fixed monthly pension, which is determined by dividing the principal balance in the pension by a divider (normally 200).
Employer contributions to Israeli pensions and the monthly pension received after retirement are fully taxable in the U.S. as ordinary income. Due to the Saving Clause, Israeli private pensions paid to U.S. taxpayers residing in Israel are normally not exempted by the U.S.-Israel tax treaty.
Some Israeli pensions are subject to special tax rules. The U.S. government taxes foreign funds that are mainly involved in the production of passive income (also known as PFICs) at the maximum tax rate for the holding period (35% until 2014 and 39.8% starting 2015) plus interest.
Employee-sponsored Israeli pensions are normally not subject to PFIC rules. However, pensions and kupot gemel funds that are set up independently and not through an employer are subject to PFIC rules. This includes children savings accounts that use a kupat gemel instead of a savings account as the investment vehicle. We strongly encourage Americans in Israel to seek tax planning in advance, as a few options are available to reduce this tax.
Bituach Menahalim (Manager’s Insurance) funds have a pension component and a life insurance component. The pension functions much like a keren pensia discussed above (with similar taxation rules), while the life insurance allows heirs of the taxpayer to receive the full amount of the fund’s principal in case of death or permanent disability. Life insurance proceeds from death or disability are not subject to US income tax.
With a few exceptions, these financial instruments are subject to FBAR and form 8938 reporting. For more information, call us now for a free 15 minute consultation (972-55-6682243) or e-mail me at nathan@savranskypartners.com.
The content of this article is intended to provide general information on the subject and does not constitute legal or tax advice. The advice and strategies herein may not be suitable for your situation. You should consult with a tax professional where appropriate.