Tax benefits of the Keren Hishtalmut Foundation for self-employed persons
The State of Israel encourages its citizens with special tax incentives to make medium-term and long-term retirement savings. By setting aside a small percentage of regular income, people ensure their financial independence in case of contingencies or old age. Various kinds of savings give an opportunity to maintain a decent standard of living during the period of unemployment or after retirement, and not to ask the state for money. Anyway, the state can only give the very minimum.
A self-employed person in Israel has several options for profitable accumulation of funds. For example, since 2017, pension savings are mandatory for all private entrepreneurs. Pension contributions are recognized by the Internal Revenue Service as an expense, accounting for which reduces the payable tax. And, here, if the atzmai does not make contributions to the special pension fund, then he will face an annual fine. For more information on the formation of pension savings for entrepreneurs and the tax benefits provided for them, see the article Pension for individual entrepreneurs.
Today, let’s talk about one of the types of medium-term savings funds Keren Histalmut. Initially, the assets accumulated in these funds were intended for study and advanced training. Keren Hishtalmut can be opened by an employer for an employee or by a self-employed person for himself. Let’s take a look at why Keren Hishtalmut is so attractive for an Atzmai (self-employed person) and how much tax can be saved thereby.
Basically, this is an on-demand deposit without any time limits. Savings in Keren hishtalmut are completely exempt from the income tax (mas akhnasah) under the following conditions:
Upon expiration of six years from opening the account and making the first installment;
After three years, provided that this money will be used for professional development or training of the account holder;
Upon reaching the retirement age by the account holder;
n the event of the death of the atzmai, the money is paid to the family.
You can withdraw money from the Keren Hishtalmut fund ahead of time, but you will have to pay 35% of the income tax.
Also, it is not worthwhile rushing to withdraw money from the Keren Hishtalmut after six years if there is no urgency for that. The entrepreneur can continue to contribute to the account and earn very attractive tax-free dividends. The rate of return in the Keren Hishtalmut is usually substantially higher than the average market provisions for savings deposits.
The entrepreneur can independently choose the frequency of replenishment of the educational fund as follows: monthly payments, periodic replenishment during the year, or a one-time transfer of the amount for the entire year.
There are two important considerations when it comes to replenishing the Keren Hishtalmut:
There is a restriction on the amount of annual profits that are eligible for tax relief, and in 2020 the ceiling for annual profits is 264 thousand shekels. An individual entrepreneur will receive a tax relief in the amount of not more than 4.5% of his net profit.
You need to be just in time to transfer the full amount by December 31 of the tax year in which the entrepreneur expects to receive a tax discount.
Experienced accountants recommend fixing a reasonable monthly payment and, when necessary, paying the balance at the end of the year.
How does the Keren Hishtalmut reduce taxes of a private entrepreneur?
Now there will be a lot of numbers and calculations, but they all are about your financial gain, so read carefully. Thus, the 4.5% annual profit cap that is covered by the tax relief led us to the maximum annual contribution to the training fund amounting to NIS 11,880. In the tax report, the contribution to the Keren Hishtalmut (within 4.5% of the annual profit) will be recorded as an expense that decreases the taxable profit (in Hebrew, nikuim). You can lay aside even more, but this will no longer affect the tax relief.
How much tax money can be saved by putting income aside into Keren Hishtalmut, let us calculate using specific examples. Suppose there is an entrepreneur with an annual profit of 240 thousand shekels. The maximum amount of deposit for him will be 4.5% of 240 thousand shekels, namely 10,800 shekels. His net tax savings will be NIS 3,348 per year. See how we arrive at this amount: the outermost tax step in the interval of annual profit between 174,961 shekels and 243,120 shekels is 31% (see more about the step-up income tax in Israel), respectively, from the contribution of 10,800 shekels we will win 31% of the tax or the same 3348 shekels …
Another entrepreneur has a net annual profit of 300 thousand shekels, i.e. it exceeds the ceiling of the annual profit, which is 264 thousand shekels. In this situation, the atzmai can make a contribution to the training fund and receive a tax break with a maximum contribution of 11,880 shekels and save 4,158 shekels in taxes.
A detailed calculation of savings in this case looks like this: the outermost step of the income tax in the annual profit interval between 243120 shekels and 505,920 shekels is 35%, respectively, from the contribution of 11,880 shekels, we will win 35 percent of taxes or 4158 shekels. And this is the maximum tax relief one can get for a contribution to the Keren Hishtalmut in 2020.
In addition to the reduction of income tax in 2020, the educational fund investor receives exemption from capital gains tax (in Hebrew masreavakh khon) in the amount of the annual deposit, which reaches 18,480 shekels, which is 7% of the annual income ceiling limit.
It is possible to replenish the Keren Hishtalmut with larger amounts, but already without income tax benefits. Amounts in excess of 4.5% of the net annual income will be considered part of the entrepreneur’s income and will be taxed according to the tax category.
It should also be taken into account that profits from deposits derived in excess of NIS 18,480 in 2020 will be subject to a capital gains tax of 25%.
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