What is a Rabbi Trust, and why should I possibly care? If you are an employer or an employee, then a Rabbi Trust can be a very good way to handle employee benefits.
An employer establishes a Rabbi Trust in order to provide future compensation to employees. It is a way for the employer to meet its obligations, typically to executives, under a nonqualified benefit plan. Employees may withdraw money from the trust only after retirement, termination, or disability. The trust got the name “Rabbi Trust” due to a 1980 IRS ruling concerning a synagogue congregation that set up a fund for its rabbi. However, these kinds of trusts are widely used in both commercial enterprises and non-profit organizations.
Benefits of Using a Rabbi Trust
The purpose of a Rabbi Trust is to offer security to employees in regard to their nonqualified benefits. If structured properly, the employee has security protection against an employer’s:
Change of Heart: An employer cannot touch the assets in the trust.
Change of Control: Any unfriendly takeover of the employer’s company will not affect the trust.
However, the employee’s assets are not protected from the claims of the employer’s creditors. If the employer files for bankruptcy, then the employee stands in line with the other creditors.
Because the employer’s creditors have access to the Rabbi Trust, the employee does not have complete control of the funds. As a result, employees have not received the full economic benefit of the fund until they make withdrawals. For this reason, the IRS requires the employer, and not the employee, to pay income taxes on the trust income. Contributions to the trust are not tax-deductible. However, the employer may deduct the full amount of the benefit payment later.
A Rabbi Trust must be structured properly to allow the employer to use it for deferred compensation, to protect the employee from the employer’s “change of heart” or “change of control,” and to allow the employee to reap the benefits of paying income taxes later. It is important to pay careful attention to IRS regulations and to any applicable ERISA rules.
Proper planning can help you take advantage of the benefits of a Rabbi Trust. Be sure to consult your team of qualified tax, legal, and financial professionals for specific guidance.
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