Getting a monthly pension? Find out if you are getting the exemption you deserve!
- How much tax do we have to pay on our pensions?
- What affects this amount?
- What is “fixation of rights” (“Kibua zechuyot” קיבוע זכויות) and what needs to be done in order to stay with a higher net pension in your bank account every month?
- How does this relate to U.S. citizens?
- What are the three things we believe every retiree should check in order to ensure they get the exemption they deserve?
Answers to the questions above and more can be found in the following series of articles.
Introduction:
Section 9A of the Income Tax Ordinance defines the formula for calculating the monthly exemption that can be obtained on the pension. This is one of the most complex sections in the Income Tax Ordinance – So much so that even some professionals are not fully familiar with the complexities.
In the next following articles, we will try to simplify the Israeli laws regarding pension in Israel. We will also give some insights that are important for US Citizens.
Do you have to pay tax on your pension?
Yes. Receiving a monthly pension from a pension fund, life insurance, provident fund, or budget pension (“pentzia taktzivit” פנסיה תקציבית), is considered an income that is taxable in marginal tax rate according to the tax brackets of personal exertion earning, just like the tax calculation on salary.
However, it is possible to receive a certain exemption from the monthly pension if one of the following two conditions is met:
- Reaching retirement age – 62 for a woman, 67 for a man
- Permanent disability at a rate of at least 75%
The exemption is usually not granted automatically. One needs to do “fixation of rights” in order to receive it.
What is “Fixation of Rights”?
Each retiree is eligible for an exemption basket of 800,000 NIS that they can receive as a monthly exemption or withdraw as a lump sum. The retiree needs to notify the Income Tax Authority on the way he/she would like to split the exemption basket between three types of exemptions: Exemption for severance package, Exemption on a monthly pension and Exemption on “Hivun Kitzba” (.(היוון קצבה
More information and Tips regarding Fixation of Rights can be found in the “Fixation of Rights” Article.
At what age can you receive a pension?
In most cases, it is possible to receive a monthly pension from the age of 60, but the exemption on the pension can only be obtained if one of the two conditions mentioned above is met.
How is the pension exemption calculated?
As of January 1, 2012, Amendment 190 to the Income Tax Ordinance came into effect and a broad and complex reform was carried out on this issue.
In principle: This is an exemption of up to 52% on the monthly amount of 8,460 as of 2021.
The percentage of exemptions is expected to increase from 2025 onwards to 67%.
The amount of the exemption does not depend on the amount of the pension and currently stands at 8,460*0.52 = 4399 NIS per month, for each monthly pension amount.
Hence, the annual tax savings for a person with a marginal tax bracket of 35% would be NIS 18,475 = 4,399*0.35*12, an amount that would have been paid to the Income Tax Authority if it were not for the exemption.
Illustrating example:
Moshe is 67 years old, receives a monthly pension of 12,000 NIS, and is entitled to a maximum exemption of 52%. What is the pension amount that he will have to pay tax on (taxable pension)?
Answer: The exempt pension is 8,460*0.52 = 4399, hence the taxable pension is 12000-4399 = 7601.
Only this amount will be taxed according to Moshe’s marginal tax bracket and credit points will be deducted from the taxable amount.
What affects the percentage of exemption we will receive on our pensions?
Amendment 190 established a formula called the “Nuschat Hakizuz” (offset formula – נוסחת הקיזוז) that calculates the percentage of exemption that can be obtained on the pension.
The main principle: There is a direct connection between exemptions received on severance packages once leaving the employer and pension exemptions received from the retirement age.
In accordance with this formula, a withdrawal of one shekel from tax-free severance packages affects 1.35 NIS in the pension exemption.
The purpose of the amendment is to encourage people who leave their employment not to take the severance package money and to leave it to retirement by imposing a “fine” of 1.35 NIS to the pension exemption for any exempt withdrawal of severance packages.
For this reason, it is worth stopping and thinking when leaving a workplace, even long before reaching the age of 60. Do we want to take advantage of the exemption on our severance package or not?
Any action taken from the moment we receive the severance package will affect the amount of the pension we will have and the tax we will pay on it.
For more information regarding the way the exemption on severance package is calculated in an article that will be publish soon.
Is there any particular reference to these exemptions in U.S. tax law?
The IRS does not recognize an exemption on severance packages or on a pension exemption percentage and considers these amounts as ordinary income subject to the marginal tax rate.
Therefore, when the retiree is a U.S citizen, it is necessary to take into consideration before making any decisions, that exemptions received in Israel may result in a significant tax charge in the annual reports to the IRS.
So, what are the three things you should check out?
- Look at your pension slip and see if the full pension exemption is accepted – if the full exemption amount does not appear, it is recommended to contact your accountant for consultation as soon as possible.
- Examine the balance of the funds available to you in provident funds and pension funds for optimal future planning in accordance with the exemptions available to you.
- In the event of leaving employment – we advise not to withdraw the severance package automatically. It is recommended to examine the 161 Form you received from the employer and do not rush to sign Form 161A. These decisions can have far-reaching implications for the pension you will receive in the future or the pension you are receiving today.
This matter will be discussed in a separate article.
The retirement department in our firm is set to assist you with patience, smile and professionalism in any matter related to planning your retirement tax and pensions.
For questions, advice and to arrange a meeting on zoom, you are welcome to contact the CPA Hai Bahalul from our office and the rest of the firm’s staff at [email protected].