Borrowing money from an Israeli pension or advanced study fund is not advisable. Here’s why:

When an Israeli who has American reporting responsibilities owns a pension or an advanced study fund, those accounts have tax implications to America. They can be taxed. Clients with American social security numbers have to put those on their American reports but may not have to pay any tax if it’s done right. This is because private pensions and annuities, such as the advanced study fund, are covered by the Savings Clause of our Treaty with America. The Savings Clause exempts private pensions, and so – maybe unexpectedly – a client who lives in Israel does not receive any Treaty protection from America in these areas. He is required to report on his Israeli pension contributions, his employer’s contributions to his  Israeli pension, and any withdrawals he makes from his Israeli pension or his advanced study fund. A client may be tempted to borrow money from his Israeli pension or advanced study fund. That is not advisable.

If there is any tax that the client has to pay to America, or how the tax can be lowered or even avoided altogether is the topic of our work here as CPAs. We work very hard to lower the taxes for our clients. The temptation for many people with American responsibilities here in Israel is to “go forward without worrying” and to “not think too much about these things because it’s too far away.” That’s a good idea if the client knows and trusts his CPA. That’s why we here as CPAs are paid good money to think for our clients. We go over these things to protect our clients.

Now, pension contributions by an employer to an employee pension are taxed when they are contributed as unearned income to the employee on that client’s American report. He has to include those contributions as income, but they are unearned. And any time a client takes out money as a withdrawal from an advanced study fund, which is considered an annuity and has tax benefits like a private pension, some of that withdrawal may also be taxable. That’s why we track the employer and employee contributions to determine how much tax could be levied if we’re not careful. Smart clients know that the tax is usually not that much, such as a tax on the small gains in the pension

Here’s why it’s not advisable to borrow from these accounts: Now because an advanced study fund is treated like a pension in American tax law, this “annuity” on the American tax side has a positive impact on the client’s tax status. Israeli pensions and annuities have preferential tax benefits over other types of investments like mutual fund securities and shares of stock, which can sometimes be taxed as a business when they’re bought, sold, or traded. We don’t want that for our clients with advanced study funds!

A second tax benefit of having a study fund or pension is the way that pensions and advanced study funds are reported for the earned income exclusion. On the IRS Form 2555, for example, pension and advanced study fund contributions are not counted as earned income for the foreign earned income exclusion. This allows the client to exclude more of his other income because these contributions are not counted.

It takes work and it’s important to maintain the pension and annuity status of these Israeli advanced study funds in order to maintain the preferential tax status along with other less known tax advantages for these and other long term investments. A little known fact is that if a client borrows money out of his advanced study fund or out of his Israeli pension, or even if a client pledges money from the advanced study fund as collateral on an outside loan, then that advanced study fund or pension immediately becomes disqualified from having its preferential tax status. Not meeting the IRS guidelines for a retirement annuity, now the entire account becomes taxable as if it were distributed to the client all at once. All the funds are taxed as a distribution at that moment, in that year. This entire balance may be treated as income that year if we’re not careful.

As some people go forward into the more stringent American reporting environment of 2020, fewer and fewer people are taking chances with their American reporting responsibilities. As the Trump Law, the American Tax Cuts and Jobs Act, has opened doors in 2017 going forward to provide incentives, lower taxes in certain ways, and forgive people who come forward trying to get caught up on their American taxes – these newer laws also have increased penalties for not complying with America’s laws.

Israeli pensions have to be reported to America by Israelis who live here, but when they are looked at very carefully and reported to America in the proper manner it is much easier for the client to look forward: further down the road, and the client should be apprised of how to move forward with the best position going forward. It is best to ask competent professionals whether you may have American tax reporting responsibilities, but not to worry: there is the American streamlined grace program afforded by the authorities among other things that assist us in coming forward and getting back into reporting properly to America.

Anyone with an American citizenship or an American social security number is required to report every year to America. Even so, when reporting properly, many times there is no tax owed by the client. And sometimes there’s even a refund whenever there was no tax ever paid! This happens more than once: this year’s economic stimulus grant, even child tax credits. People who live in Israel who have children who are American citizens can receive money in refunds every year to help them live here and meet their challenging financial responsibilities. Some of that extra money — you can be sure — can be invested in securities, put into a pension, or used to start a small business.

American taxes don’t have to be scary, but they’re not meant to be avoided. They’re just like any responsibility: they’re only scary for those who avoid them. For those who take care of their American reporting responsibilities and face them squarely with an intention of satisfying the authorities – it’s a job well done. This should make our clients happy. We here at Weinstein are happy to do any work our clients give us, thoroughly, completely, reliably and with good hands on our work. Hands down, we want happy, successful clients all around and all the way going forward.