The interplay between US and Israeli tax obligations can significantly impact how pensions and investments are taxed and managed.
This article breaks down essential topics such as the US-Israel tax treaty, pension taxation, investment strategies, and estate planning to help retirees maximize their financial security and avoid costly tax pitfalls.
Understanding the US-Israel Tax Treaty
The US-Israel Tax Treaty provides specific rules for income earned in either country. Key provisions include:
- Citizens and residents of either country may claim foreign tax credits or exemptions for taxes paid to the other country.
- For retirees, pensions are generally taxed only in the country of residence, meaning that US citizens living in Israel typically pay Israeli taxes on US pension income.
- The treaty limits the amount of tax that can be withheld on dividends, interest, and royalties, ensuring lower tax rates on these types of income.
Israeli taxation of US pensions
US tax liability on pension income
Even while living in Israel, US citizens must report worldwide income, including pension income, on their US tax returns. The taxability of pension income depends on the source and type of pension.
Common sources include Social Security benefits and private pensions. However, under the US-Israel tax treaty, pensions are generally taxable only in the country of residence, which for retirees in Israel would mean Israeli taxation.
Israeli tax liabilities on pension income
In Israel, US pension income is generally considered taxable for residents. For US expats, this means that they are required to report and pay taxes on their pensions in Israel.
However, Israel provides tax exemptions for certain pension income, particularly for new immigrants and returning residents, as part of the country's tax benefits for new residents. These exemptions may apply to pension income received from outside Israel for a period of up to ten years.
Strategies for minimizing tax liabilities
To minimize tax liabilities on US retirement income, retirees can use several strategies:
- US citizens living in Israel can claim foreign tax credits on their US tax returns for taxes paid to Israel, thereby reducing their US tax liability.
- New Israeli residents or returning citizens may be eligible for pension tax exemptions, reducing Israeli tax liabilities.
- The US-Israel tax treaty helps retirees avoid double taxation by ensuring that pension income is taxed only in one country.
Israeli pension systems for US expats
Israel's pension system consists of three main pillars: a government-mandated basic pension, employer-sponsored pensions, and private savings.
Contributions to employer-sponsored pensions are mandatory for employees, with both employers and employees contributing a percentage of salary.
For retirees, this system provides monthly payments based on lifetime contributions, similar to Social Security in the United States.
Comparison with US pension plans
While both countries aim to support retirees financially, US retirement plans - such as 401(k)s and IRAs - are often more flexible regarding contribution amounts and withdrawals.
Israel's pension system requires higher employer and employee contributions, which provides a more consistent pension payout at retirement.
In contrast, US retirement plans allow for more individualized savings strategies, with investment choices varying based on risk tolerance and personal financial goals.
Optimize deposits and withdrawals
For US expats, optimizing pension contributions and withdrawals requires careful planning. Key strategies include
- Maximize contributions. Contributing the full required amount to the Israeli pension system ensures higher future payouts.
- Coordinate US and Israeli pensions. Expats should consider the interplay between the US and Israeli pension systems to avoid over-taxation and ensure smooth pension income streams.
- Timing withdrawals. Planning withdrawals based on tax treaty benefits can help minimize tax liabilities in both countries.
Compliance and reporting requirements
IRS reporting requirements
US citizens must file an annual tax return with the IRS reporting worldwide income, including pension and retirement income earned in Israel. Consultation with a US tax accountant can ensure proper compliance with these obligations.
In addition, expats with foreign bank accounts that exceed $10,000 at any time during the year must file a Foreign Bank Account Report (FBAR).
Other reporting requirements may include filing Form 8938 under FATCA for those with substantial foreign financial assets.
Israeli filing requirements
In Israel, US expats must report their worldwide income, including US pension income, to the Israeli tax authorities. This is especially important for individuals who have become Israeli tax residents.
Israeli residents may also be required to report foreign bank accounts and other foreign-held assets. Israel has strict reporting requirements for those who meet certain thresholds, and non-compliance can result in penalties.
Estate planning and estate tax
Understanding US and Israeli estate taxes
In the United States, inheritances in excess of the exemption amount are subject to estate tax, while in Israel there is no estate tax.
US citizens should consider the potential inheritance tax when planning their estates. The US estate tax exemption is indexed for inflation and is $13.6 million per person in 2024.
Strategies for efficient estate planning
- Take advantage of the estate tax exemption. By making lifetime gifts, expats can reduce the size of their taxable estate and take full advantage of the exemption.
- Consider double taxation. Ensure that the estate planning strategy takes into account potential taxes in both countries, even though Israel does not have an estate tax. It may still impose taxes on income from inherited assets.
- Trusts and other vehicles. US expats can use trusts, life insurance and other estate planning tools to shield assets from heavy taxation and protect them for heirs.
Retirement and investment strategies
- Diversify your retirement investments
To minimize exposure to market volatility, expats should invest in a variety of asset classes, including stocks, bonds, and real estate, both in the US and internationally. Diversification ensures a balanced risk/reward ratio.
- Maximize growth with tax-efficient investments
Expats can use tax-advantaged investment accounts, such as US IRAs and Israeli tax-advantaged savings vehicles, to maximize growth.
By investing in tax-advantaged accounts, expats can defer tax payments, allowing for more compounding growth over time.
- Risk management and insurance
Risk management is critical, and retirees should protect their assets with appropriate insurance.
Life insurance, health insurance, and long-term care insurance are essential to ensuring financial security in retirement.
Bottom line
US expats living in Israel face unique challenges when it comes to managing taxes, pensions, and investments. By taking advantage of the US-Israel tax treaty, utilizing tax credits, and implementing smart estate and retirement planning strategies, retirees can ensure financial security and maximize income while living abroad.
Careful planning is essential to minimize tax liabilities and optimize retirement savings for a successful and comfortable retirement in Israel.
