Israeli pensions and keren hishtalmut: what the IRS sees that Israel doesn't

Israel built its pension system to be tax-friendly for Israelis, but the IRS doesn't recognize any of it, so US citizens in Tel Aviv need a plan for how to report it.

The short version

• Almost every Israeli employee gets a pension. Under the national expansion order, the minimum contribution has been 6% of salary from the employee and 6.5% from the employer since 2017, plus a severance component [4].
• Keren hishtalmut (a study fund) is a popular perk. Employer contributions are tax-free in Israel, and the money can come out tax-free after six years, up to a ceiling [5].
• The US doesn't treat either one like a 401(k). The US–Israel tax treaty has no rule that defers US tax on Israeli pension savings, and its saving clause lets the US tax its citizens as if the treaty didn't exist [3].
• Watch for PFIC and foreign trust rules, especially on the keren hishtalmut. Practitioners disagree on how to treat it [1][2][6].
• Report the accounts: FBAR, usually Form 8938, and possibly Forms 3520 and 8621. A US expat tax preparer can check your situation [7][8].

How Israeli workplace savings work

Your Israeli payslip (tlush maskoret) usually shows deductions for two long-term savings vehicles. Here's how they stack up against what you knew stateside:

The pension

Since January 1, 2017, the minimum under the expansion order (tzav harchava) has been 6% of salary from you and 6.5% from your employer, with a severance (pitzuim) contribution on top [4]. Your money goes to a pension fund, a managers' insurance policy (bituach menahalim) or a provident fund (kupat gemel) run by an Israeli insurance company or investment house. Self-employed residents also have to save for a pension, under different rules.

Keren hishtalmut

The keren hishtalmut started as a fund for continuing education but has turned into Israel's favorite medium-term savings account. The employer's share is exempt from Israeli income tax, and after six years you can withdraw the balance tax-free up to a ceiling tied to salary [5]. Self-employed people can contribute too, and part of that is deductible in Israel [5].

One Israeli change to watch: a 2024 Treasury budget proposal would tax gains earned after six years when they're withdrawn, while keeping gains through early 2025 exempt [5]. Check its status with your fund before assuming anything.

Why "tax-free in Israel" isn't tax-free for Uncle Sam

As a US citizen, you're taxed on your worldwide income no matter where you live. The US gives special treatment to US-qualified plans like 401(k)s and IRAs, not to foreign ones, unless a treaty says otherwise.

What the US–Israel treaty does and doesn't do

The US–Israel income tax treaty was signed in 1975 and has been in effect since January 1, 1995 [3][8]. The relevant pieces:

• Article 20 (private pensions and annuities) says pensions are generally taxed only in the country where the recipient lives [3]. That's about payouts, not the years of saving.
• Article 6, paragraph 3 (the saving clause) lets each country tax its own citizens as if the treaty weren't there [3]. Article 20 isn't on the list of exceptions, so it doesn't stop the US from taxing a US citizen living in Israel [3].
• Article 21 (social security payments) covers government social security payments and is on the exceptions list [3]. That's Bituach Leumi territory, not your workplace pension.
• Article 26 (relief from double taxation) is also an exception, and it's how foreign tax credits fit in [3].

The upshot: unlike the US–UK treaty, there's no treaty clause that lets a US citizen defer US tax on contributions and growth in an Israeli pension. The US treatment then depends on the US tax code alone.

The pension under US rules

Without a treaty, an Israeli employer pension is generally a foreign, non-qualified plan for the IRS. Tax preparers commonly analyze it as an employees' trust under Internal Revenue Code section 402(b), which can mean:

• employer contributions may be taxable to you when they're made, or when they vest
• growth may or may not be taxed each year, depending on how the plan is analyzed
• your later payouts are partly a tax-free return of what you were already taxed on

Positions vary, and the stakes go up with salary and years of service. This is classic "talk to a professional" territory.

The keren hishtalmut under US rules

The keren hishtalmut is where Americans get burned. For the IRS:

• The employer's contributions are generally taxable income in the year they're made, even though Israel exempts them.
• Earnings are generally taxable too, often every year, not after six years.
• The six-year tax-free withdrawal is an Israeli benefit only. The IRS doesn't follow it.

The good news is that you can often offset the US tax with the foreign earned income exclusion or foreign tax credits, because Israel's tax rates are high. The bad news is the paperwork.

PFICs and foreign trusts: the scary acronyms

PFIC

A passive foreign investment company (PFIC) is, roughly, a foreign mutual fund or ETF. US persons who hold PFICs, directly or indirectly, may have to file Form 8621 every year [1]. The default PFIC tax treatment is punishing: gains are taxed at the highest rate, plus an interest charge.

If your keren hishtalmut or pension fund is invested in pooled Israeli funds, some preparers treat the underlying holdings as PFICs. Others argue the PFIC rules don't apply to a pension or employees' trust. Where you land depends on how the account is classified. That's why many Americans ask their fund for an investment track (maslul) holding individual securities rather than pooled funds. Our PFICs guide explains the mechanics.

Foreign trust reporting

Some Israeli plans may be treated as foreign trusts, which brings Form 3520 (and the trust's Form 3520-A) into play [2]. Revenue Procedure 2020-17 exempts US taxpayers from those forms for two kinds of tax-favored foreign trusts [6]:

• retirement trusts, funded only from earned income, with contributions capped (for example, at USD 50,000 a year or USD 1 million lifetime, or as a percentage of earned income), and withdrawals limited to retirement, disability or death, or penalized if taken early
• non-retirement savings trusts for medical, disability or educational benefits, with contributions capped at USD 10,000 a year or USD 200,000 lifetime

An Israeli pension fund will often fit the retirement test. A keren hishtalmut is harder: it's nominally for education, but money can come out for any purpose after six years. The revenue procedure also says plainly that it doesn't change Form 8938 or FBAR reporting [6].

The reporting checklist

Here's how the forms usually line up. The thresholds are fixed dollar amounts that apply to both tax year 2025 and 2026 filings; the Form 8938 figures shown are for people living abroad [7]:

Most preparers count Israeli pension and study fund balances toward the FBAR total, so a mid-career tech worker in Tel Aviv usually crosses the USD 10,000 line in no time.

A practical game plan

1. Get your annual statements (doch shnati) from each fund, in English if possible, with contributions split into employer, employee and earnings.
2. Pick a consistent position for each plan with a US expat tax preparer, and apply it every year.
3. Consider your investment tracks. Individual-security tracks can reduce PFIC exposure.
4. Check Rev. Proc. 2020-17 for each plan before filing a Form 3520 you may not need [6].
5. File the FBAR by April 15, with an automatic extension to October 15.
6. Behind on filings? The Streamlined procedures exist for people who didn't know. See our guide below.

To compare notes on how other Americans handle their kupot, try our community group for Americans in Israel.

Sources

1. About Form 8621, Information Return by a Shareholder of a PFIC or QEF, IRS
2. About Form 3520, Annual Return to Report Transactions with Foreign Trusts, IRS
3. United States–Israel Income Tax Convention (1975), IRS
4. Legal Update on Pension Requirements in Israel, Yigal Arnon and Co. via Mondaq (April 2017)
5. Maximizing your savings: all the ways to optimize your study funds, Israel Hayom (October 2024)
6. Revenue Procedure 2020-17, IRS
7. Comparison of Form 8938 and FBAR requirements, IRS
8. Israel tax treaty documents, IRS

Keep reading

• Israeli taxes for Americans: how they fit with your US return
• Bituach Leumi: Israel's national insurance
• PFICs: why foreign funds hurt Americans
• Catching up on missed US tax returns: the Streamlined procedures