What is an IRA?
IRA (individual taxation Retirement Account) is alike to a ‘Kupat Gemel’ in Israel, both of which are a retirement savings account where funds are managed by the account holder.
It is a popular pension plan that originated in the U.S., but IRAs also exist in Israel.
The plan benefits the owner- or the owners close relatives- and provides them either a lump sum or monthly payments upon retirement. These plans are typically offered through insurance companies, banks, or financial institutions and there are various types all managed differently.
Generally, a personally managed retirement plan is the most tax-efficient for its owner. Typically, an IRA contains assets on which tax has already been paid, so when payments are made to the beneficiary, they are not taxed (including accrued gains). Alternatively, assets entering the account will be tax-free, but upon payout, the payment is subject to tax.
Prior to opening an IRA, and during the savings period, it is crucial to consult a professional (i.e. accountant, lawyer, or tax consultant) to clarify the tax implications. For professional advice, contact us today.
IRA Taxation for Israeli Residents Who Aren’t U.S. Citizens
Under the provisions of the U.S.-Israel double taxation treaty, an Israeli resident who is not a U.S. citizen and receives payments classified as pension, is subject to tax only in Israel.
However, many are unaware of Article 20(1) of the U.S.-Israel tax treaty, and end up paying unnecessary tax on their IRA in the U.S. Such payments are considered as “voluntary tax” and according to the Israeli Tax Authority, tax credits cannot be claimed for these payments. This further emphasizes the importance of consulting a tax professional.
In certain past cases, we have submitted requests to the IRS for refunds for previous years due to unnecessary tax payments on IRAs.
Israeli Resident who is a U.S Citizen
For a returning resident who also holds U.S. citizenship, the situation is more complex. Despite the tax treaty, the U.S. holds the right to tax all income of its citizens, even if they live abroad. (Known as the ‘Saving Clause’).
Therefore, U.S. citizens are liable for taxes on an IRA, even if the funds were inherited or stem from parental pensions, etc. On the other hand, Israel also has the right to claim taxes- this effectively creates a situation of double taxation, under the law!
In order to address this, Article 26(2) of the treaty is applied. This article requires the U.S. to resolve the double taxation issue created by residency status.
The solution: The IRA is taxed in Israel (primary tax right) and the U.S. can exercise their residual tax right, in condition they provide a credit for Israeli taxes paid. For further understanding, it is essential to consult with a tax advisor or CPA.
Pension Exemption
Section 9b of the Income Tax Ordinance provides a comprehensive exemption of 35% of the annual pension received from foreign pensions and is mainly applicable for high-income cases since there is no ceiling. However, Section 9b is just one of the existing solutions.
Section 9c is more applicable to the average person, as is Section 9a.
Taxation on IRA Payments for New Immigrants/Returning Residents
A new immigrant from the U.S. with a 401k or IRA (or any other pension plan) benefits from certain tax breaks in Israel. Income for an American Pension is Tax free for the first ten years after immigration. Even after the ten years, new immigrants pay the tax-rate applicable to the pension funds in their country of origin.
Returning residents who are not U.S. citizens receive a larger tax break. As stated in article 20(1) of the Israel-U.S. double tax treaty, an individual receiving a private pension is not taxed in source country of the funds but only in their country of residence. Since returning residents are also entitled to a ten-year exemption from Israeli pension, they are not liable for tax in either Israel or the U.S.
In cases of returning residents who are U.S. citizens, the situation is more legally complex to regulate. The agreement between the two countries results in a situation where the returning resident enjoys a tax exemption on the pension in Israel, but it still taxed in the U.S.
What is a Roth IRA?
Created by U.S. Senator William Roth, it is a type of personally managed pension plan established in 1998.
Unlike a regular IRA, the tax is paid at the time of deposit in the U.S. and from that point on, all distributions are tax-free in the U.S. (including gains).
Additionally, when Roth established this there was an option to convert regular IRAs to Roth IRAs, with the payment of tax on profits accrued at the time.
However, the problem with Roth IRAs, is they result in double taxation in relation to Israel taxes, due to the fact that there is no tax credit in Israel.
In certain cases, we reached an agreement with the Israeli Tax Authority to exempt tax on IRA-to-Roth Ira conversions while allowing a full credit for U.S. tax paid (at the time of the conversion in the U.S.) so future distributions are taxable. In other situations, we agreed to forgo the tax credit for the U.S. tax paid, in exchange that the distributions remaining were non-taxable in Israel.
The Transfer of U.S. IRA Payments as an Israeli Citizen
The IRA account holder can choose to bestow the accounts rights (payments) to various beneficiaries. If the IRA owner is an American citizen, regardless of the heir’s citizenship, the heir must pay income tax on the retirement plan.
If the heir is Israeli, it must be assessed whether the inheritance will be taxed as income.
According to the Income Tax Ordinance, any income generated, whether in Israel or abroad is taxable. At first glance one might think that the IRA would not be taxed as it is an inheritance, however, the Israeli Tax Authority’s perspective is to examine an IRA as similar to an inherited property.
In regards to periodic payments from the IRA- due to the fact that they are classified as income, they are therefore subject to tax.
Our firm handles complex cases of IRA taxation and established agreement with both the Israeli Tax Authority and IRS regarding this matter.
For consultation with a tax expert-contact us today!
