Looking for ways to defer compensation for executives?A rabbi trust may be right for your organization. Similar to a vested trust, a rabbi trust is a type of nonqualified deferred compensation arrangement that allows employers to transfer amounts to an irrevocable trust to be held for the benefit of executive employees. In case you're wondering, the name is derived from the fact that it was first used to provide deferred compensation for a rabbi. Rabbi trusts offer assurance that future benefit obligations will be performed.
How do rabbi trusts meet IRS approval?The following conditions must exist:
1. If the employer files for bankruptcy, the rabbi trust's assets must be made available to all the general creditors of the employer.
2. If the employer's net worth falls below a certain point, there shall be no insolvency triggers that hasten payments to employees and thus bypass creditors before insolvency is declared.
3. If the employer reaches a point of bankruptcy or financial hardship, there shall be a procedure to provide notice to the trustee.
The employee is not subject to tax on the deferred amounts until payments are actually received because the employer is considered the owner of the trust, subject to the claims of the employer's general creditors. Once payments are received and the executive is taxed, the employer is allowed to take a corresponding deduction.
Why use rabbi trusts?They can:
* offset IRS limits on qualified plans (as an excess benefit plan)
* provide a voluntary deferred compensation plan
* supplement an executive's retirement plan
Though less frequent, rabbi trusts can be included in executive incentive plans, director retirement plans, golden parachute plans, and termination agreements.
The IRS has issued a model rabbi trust form that provides taxpayers a safety net when they adopt and maintain grantor trusts in connection with unfunded deferred compensation arrangements. The IRS has also approved an arrangement under which executives contributing the maximum amount to a 401(k) plan can make additional deductible contributions to their employer's nonqualified supplemental savings plan funded by a rabbi trust. All contributions to the trust are inaccessible by employees and are not presently taxable to plan participants. Any amounts distributed under the nonqualified plan are not taxable to employees until cashed or otherwise made available.