Mr Zygier, a Jew from Melbourne who moved to Israel, became a citizen and joined its army, was detained in 2010 but his case was kept under wraps until last February when an Australian television expose uncovered it.
The reasons for his detention remain top secret in Israel and his family has not commented.
The justice ministry said in a statement yesterday: "The reasons the state agreed to pay this sum stemmed from its desire to avoid a court hearing in which details that could harm national security might be revealed."
It said Mr Zygier's family had accused Israel of negligence in the so-called Prisoner X affair and had sought compensation.
Reports last year said Mr Zygier, who had been working for Israel's Mossad spy service, had unwittingly given away classified information about Lebanese informants, who were later arrested and jailed in Lebanon.
In December 2010, Zygier hanged himself in an isolation cell in Ayalon Prison near Tel Aviv.