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17 June 2014

Taxation of pension income

The taxation of pension income is one of the most complicated areas of law due to the various and numerous exemptions available.

Fully exempt pensions
Pensions which are not subject to tax whatsoever include the Bituach Leumi old-age and bereavement pensions and reparations received by Holocaust survivors. Also fully exempt are disability pensions, whether received from Israel or abroad.

A person receiving a survivors pension can receive the first NIS 8,470 per month (correct for 2014) tax free. Of any excess, 35% of the pension is also tax free, with the rest subject to tax.

Other pensions

In short, the exemptions start when the taxpayer reaches pensionable age; currently 67 for men and rising from 62 to 64 for women. Before that age, pensions are fully taxable (in general), and also subject to Bituach Leumi (although the Bituach Leumi paid does reduce the tax burden in such cases)
 
Foreign pensions (i.e. paid by non-Israeli providers)

Once you reach pensionable age, 35% of the pension is tax free, with the rest subject to tax according to your marginal rate of tax. However, in most cases the tax on the entire pension (i.e. before the 35% limit) is limited to the tax that would have been paid in the host country had the taxpayer been a resident in that country and only had the pension income. This can lead to many people not being taxed on such pensions. Of course, Double Tax Treaties should also be checked to see if any pension can be exempted in either Israel and/or the country of origin.

Israeli pensions

In short, everyone is eligible to a certain amount of their pensions to be exempt from tax. The exemption is a fixed amount for each person, and is not linked to the actual pension to be paid. The exemption is calculated as a percentage of NIS 8,470 per month (correct for 2014) - but obviously the exemption cannot exceed the total pension to be paid. The exact percentage depends on the amount of tax-exempt severance pay that the pensioner received during the last 32 years of their salaried work-life; the calculation is complicated and this is not the forum to explain it in detail. Suffice to say that (1) if you took the maximum tax-free severance pay, your percentage is set to 8.5% and (2) if you took no tax-free severance pay, your percentage is set to 43.5%. Anything in the middle will give you a percentage somewhere between 8.5% and 43.5%.

The above percentage range is relevant for the 2012-2015 years, and is set to rise in the future:
  • In the years 2016-2019, the range is set to rise to 14% - 49%
  • In the years 2020-2024 the range is set to rise to 17% - 52%
  • From 2025 and onwards the range is set to rise to 32% - 67%.
That being said, it would not be unheard of for the rules to be changed in the interim, so be sure to be aware of any (proposed) changes.

It is also important to take proper advice when considering taking tax-free severance pay, based on the above - the reduction in percentage of exempt pension affects your taxable pension for life!

3 comments:

  1. If you have a US 401k or a Roth IRA, are those considered pensions?

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  2. From my US CPA colleagues, I understand that a 401k is a pension. A Roth IRA is a very grey area though

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  3. Thank you. That is exactly the info I needed.

    ReplyDelete