Working Pensioners in Israel: How to Choose the Right Tax Exemption Strategy

One of our key areas of expertise is pension taxation in Israel. We help clients who have reached retirement age arrange their pension tax exemptions, a process known as kibua zchuyot. A detailed explanation of this procedure is available in a video on our channel.

Today I would like to discuss an issue we encounter quite often. In Hebrew it is referred to as “prisha meduma,” which literally means “artificial retirement.” Despite the wording, this situation is entirely legitimate. It describes a case in which a person reaches retirement age, becomes eligible to withdraw pension savings, and even starts receiving pension payments while continuing to work. In practice, the individual remains employed and receives a pension at the same time, and the law fully allows this arrangement.

Why does this issue arise? A working pensioner who has not completed kibua zchuyot may find themselves facing a significantly higher tax burden. Pension payments, just like salary, are treated as taxable income. Through the kibua zchuyot process, we arrange a partial or full tax exemption on the pension, which can substantially reduce the overall tax liability.

The simplest situation is when a person chooses to draw their pension from all of their accumulated funds, both tagmulim and pitzuim. In this case, they simply receive the accumulated amounts as pension payments and are not entitled to any additional employer grants.

However, there are many other scenarios. A person may begin receiving pension payments (tagmulim) now while planning to withdraw their pitzuim later, after fully leaving employment. Another common situation in Israel is when an individual receives pension payments, tagmulim, and pitzuim, and is still entitled to additional employer grants. This is especially typical among public sector employees and teachers.

In these situations, a choice must be made. A person needs to decide whether to reserve the tax exemption for the pitzuim they will receive in the future or to forgo the reservation and obtain the maximum pension exemption now. It is essentially a balance between two options.

• In the first scenario, the individual reserves the exemption for pitzuim, pays a higher tax on their pension today, and later receives the pitzuim fully exempt from tax.
• In the second scenario, the person accepts that the pitzuim will be taxed in the future but receives the maximum pension exemption immediately.

The future tax rate may also be significantly lower, as income typically decreases after leaving employment.

When we explain these options, clients often ask which path is the “right” one. This is precisely where the expertise of a skilled advisor becomes essential. In essence, there are two strategies: reserving the exemption for pitzuim or choosing not to reserve it.

The choice can be viewed as two sides of a scale.

• Option A: Reserve the exemption for pitzuim. The pensioner pays a higher tax on their pension now, and the pitzuim received in the future are entirely tax-exempt.
• Option B: Do not reserve the exemption. The pensioner receives the maximum exemption on their pension today. The pitzuim will be taxed later, but at the rate applicable at the time of retirement. That rate is usually much lower because income typically decreases after leaving employment.

There is also a mechanism that allows pitzuim to be divided into several portions, which can further reduce the overall tax.

This type of analysis often reveals solutions that are not obvious at first glance. In some situations, we do recommend taking the maximum pension exemption and not reserving the exemption for pitzuim. This approach is particularly suitable for individuals with high salaries and high future pension entitlements who plan to continue working for many years. During the period before retirement, their tax rate remains high, which means the tax savings on the pension can be substantial. After they stop working, their income decreases, and the pitzuim may be taxed at a minimal rate or may not be taxed at all. It is also possible to divide the pitzuim into several parts, which further reduces the tax burden.

There are, however, situations in which reserving the exemption for pitzuim is the more appropriate choice. Determining the optimal strategy requires considering several factors.

• First, the length of time the individual plans to continue working. The longer this period, the less advantageous it becomes to reserve the exemption, since the potential tax savings on the pension are greater during these years.
• Second, the size of the future pension. A higher pension often indicates that reserving the exemption may not be beneficial.
• Third, the individual’s salary level and corresponding tax rate. The higher they are, the stronger the case for not reserving the exemption.

In the end, an expert brings all the relevant information together, builds an individual tax forecast, and shows the client which scenario results in the lowest tax burden and which option is truly optimal for their specific circumstances.

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