Israeli Tax Law Allows 'Phantom Retirement' to Secure Tax-Exempt Severance

Israeli tax law allows individuals aged 67 who begin receiving pension payments while continuing to work to declare a 'phantom retirement.' This allows them to secure tax-exempt status for future severance pay by filling out Form 161D, which requires them to declare both their continued employment and the amount of tax-exempt severance they expect to receive upon their eventual departure.

The tax exemption for severance pay is capped at NIS 13,750 per year of service, a sum that has been frozen since 2026. For example, an employee with an insured salary of NIS 18,000 and eight years of future service could anticipate up to NIS 110,000 in tax-exempt severance. If this amount is not declared on the form, the full severance payment would be taxed as marginal income upon retirement.

However, securing this tax exemption reduces the current monthly tax-exempt portion of the pension. According to a specific formula, every shekel of tax-exempt severance drawn in the 32 years preceding eligibility reduces the overall tax-exempt pension 'basket' by approximately 1.35 shekels. The total exempt pension basket in 2026 stands at NIS 976,005. Securing NIS 110,000 in severance would reduce this basket by about NIS 148,500, consequently lowering the monthly tax-exempt pension by roughly NIS 800.

This creates a trade-off: a lower net monthly income now in exchange for a tax-exempt severance package later. Alternatively, not securing the severance in advance results in a higher tax-exempt pension today but incurs marginal tax on the severance pay when employment ends. The updated Form 161, consolidated since 2024, requires employers to specify the severance amount converted to a pension in a dedicated section, a detail that can lead to errors if not properly understood by both employer and employee regarding its dual classification.