What Is a Rabbi Trust?
Let me explain what a rabbi trust is—it's a non-qualified employee trust that employers set up to support non-qualified benefit obligations to their employees. This type of trust got its name from an IRS private letter ruling that first approved it for a rabbi and his congregation, and the term has stuck ever since. In essence, it's designed to benefit both you as the employer and your employees by providing a secure way to handle these benefits.
Key Takeaways
You should know that companies typically use rabbi trusts to give senior executives extra benefits on top of their regular compensation. Remember, these trusts do a lot, but they don't keep creditors away. If your company declares bankruptcy, the funds in the rabbi trust can be claimed by creditors.
Understanding Rabbi Trusts
A rabbi trust gives employees security because the assets are out of the employer's control and are usually irrevocable. Once you as the employer contribute to it, you can't take the money back. However, a big downside is that it doesn't protect against creditors—if the company goes insolvent or bankrupt, both beneficiaries and creditors can access those assets. For instance, if there's $500,000 in stock and cash in the trust, everyone involved would be going after it.
Rabbi Trust Protection
This trust protects employees from a company in financial trouble that might try to pull assets out to cover other costs. You can't, as an employer, withdraw $50,000 from the trust to pay wages, for example. Once set up, you can't change the structure, which adds protection for the beneficiaries. Importantly, if your company gets taken over, the new owners can't alter the trust's terms—only the beneficiaries have that power.
Rabbi Trust Taxation
For employees, a rabbi trust offers tax perks—contributions don't count as part of your wages. If you earn $100,000 a year and your employer adds $1,000 monthly to your rabbi trust, your taxable income stays at $100,000; you skip taxes on that $12,000 yearly. The assets grow tax-free until you withdraw them, much like a qualified retirement plan. But companies get no tax benefits, which limits its appeal compared to other trusts.
Who Benefits From a Rabbi Trust?
The main people who benefit are senior executives or employees getting extra perks beyond standard pay, like deferred compensation.
Are There Tax Benefits for Employees With a Rabbi Trust?
Yes, you as an employee don't pay taxes on contributions, and you defer taxes on earnings until withdrawal, allowing for tax deferral.
Can the Employer Change the Terms of the Rabbi Trust?
No, once established, the trust is irrevocable, so you as the employer can't change its terms, ensuring security for beneficiaries.
The Bottom Line
A rabbi trust is a practical tool if you're an employer offering extra benefits to employees, especially executives—it gives tax advantages and some protection from financial issues, but it won't shield assets from creditors in bankruptcy, so it's not as secure as other trusts.
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