Understanding Rabbi Trust
A rabbi trust is a special type of trust created to safeguard non-qualified benefit obligations that employers owe to their employees. This concept originated when a rabbi and his congregation received approval from the IRS through a private letter ruling, hence the name ‘rabbi trust’. Essentially, it aims to benefit both employers and employees.
How Rabbi Trusts Secure Your Future
A rabbi trust provides a layer of security for employees as its assets are generally safeguarded from the employer’s direct control and usually set up in an irrevocable manner. Simply put, once an employer contributes to a rabbi trust, they cannot pull back those contributions.
Key Takeaways
- Executive Benefits: Often, rabbi trusts are employed by companies to offer additional benefits to their senior executives.
- Credit Risk: It’s important to note that while a rabbi trust provides many protections, it doesn’t protect against creditors.
- Bankruptcy Situation: In cases where a company declares bankruptcy, creditors might have claims over the assets in a rabbi trust. For example, if a rabbi trust holds $500,000 in stock and cash, both the company’s creditors and the trust’s beneficiaries may pursue those assets.
Securing Assets with Rabbi Trusts
A rabbi trust can prevent an employer from dipping into the trust’s assets during financial duress to fulfill other obligations. For instance, an employer cannot withdraw $50,000 from a rabbi trust to settle employee wages. Once a rabbi trust is established, its structure is irrevocable, ensuring maximum protection for beneficiaries. Even if a takeover occurs, the new administration cannot alter the trust’s terms — only the beneficiaries hold power over any modifications.
Taxation Benefits
One major upside of rabbi trusts is the taxation advantage they offer to employees. Contributions made into the trust are not recorded as the employee’s wages immediately. Taking an example, if an employee’s annual salary is $100,000 and their employer contributes $1,000 to a rabbi trust monthly, the employee’s taxable income remains at $100,000, excluding the additional $12,000 contributed to the trust. Further, the assets within the trust can grow tax-free until they are withdrawn by the employee, resembling the benefits seen in qualified retirement plans.
However, it’s crucial to notice that while employees enjoy tax advantages, companies do not receive similar tax benefits. This aspect can make a rabbi trust less appealing from a corporate perspective compared to other types of trusts.
Related Terms: Non-qualified Benefit, Employer Trust, Irrevocable Trust, Qualified Retirement Plan.
