Kranot Hishtalmuyot or Sabbatical Funds are a great employer benefit for the employee and are arguably the most attractive tax savings investment vehicle in Israel. These funds were originally meant for employees to be able to study after 6 years of working, in line with the Biblical “Shmita” year when the land lies fallow to rest and regenerate. However, over past decades these funds are more typically used for large purchases such as a downpayment for a house, renovations, cars, vacations. We spend much of our time advising against using these funds for consumption due to their unique tax free status.
The main benefit of Kranot Hishtalmuyot is that capital gains, dividends, interest income are all tax-free in Israel. Given that the tax rate on investments ranges from 15-30% in Israel, this is significant. Due to this tax benefit, contributions to a Keren Hishtalmut are capped each calendar year and therefore some consideration is needed before losing these tax-free invested shekels and redeeming.
However, many see the 6 year date as a termination and have been waiting anxiously for these funds to become liquid and redeemable without penalty. We typically advise for these funds to remain in their tax-free wrapper and be used as a primary savings vehicle and as a supplement to retirement savings or for gifting to next generation.
However, for a US citizen this unique Israeli financial product does not translate well and there are serious issues that make this great product a potential minefield.
The first and relatively easy issue are the FBARs – all kranot hishtalmuyot should be reported on your annual FBAR. The second issue, which is a bit more challenging, is taxation by the US. The employer’s contibution (7.5% of annual contribution) as an employee benefit should be included on annual tax return. The third issue is how to treat the profit, capital gains, dividend and interest that have accrued from the contributions.
This is where we could easily say consult with your local CPA or tax preparer who will try to explain to you the issues, but you might walk away more confused. Kranot Hishtalmuyot are passive foreign investment company (PFIC), this is a complex area – see http://en.wikipedia.org/wiki/Passive_foreign_investment_company
Suffice it to say this jungle is not worth entering for a ~US$3.5k annual contribution savings product. We at PFS have a solution for Kranot Hishtalmuyot that avoids the PFIC issue entirely and lets you continue to benefit from the advantages while minimizing the complexity and costs from dealing with the US authorities.