Rabbi Trust

A Rabbi Trust is an irrevocable trust established and maintained by employers to set aside funds for their employees' benefit. The trust aims to provide security to employees by setting aside funds from the employer's general assets for their benefit.

Companies cannot withdraw funds from the trust to meet losses or expenses. Furthermore, any changes in management or mergers & acquisition do not affect the trust's funds. Only the beneficiaries have the power to change the details of the trust. However, creditors can claim trust funds to pay their outstanding dues if a company declares.

• Rabbi Trust is a non-qualified employee trust created to increase the employer and employee's mutual benefit and welfare.
• It ensures the safety and tax-free growth of the employees’ funds, assuring firms retain talented senior executives for business growth.
• The employer created the trust to benefit the employees in every situation except for bankruptcy and not to allow or protect the exploitation of employees by the employers.
• A significant difference between Secular and Rabbi Trust is that funds in the former remain safe from creditors, and creditors can claim it in the latter.

Rabbi Trust is defined as a special trust established by employers to provide a safe fund for the non-qualified benefit of their executives. Moreover, the Internal Revenue Service (IRS) authorized a Rabbi and his group to establish and use this type of trust in a private letter and Revenue Procedure 92-64, later known as Rabbi Trust. The Rabbi Trust plan aims to provide additional benefits to its employees in a secure and tax-efficient manner.

The trust's grantor is any company that creates it, and the trustee is the entity in charge of its daily operations, overseeing its management and administration.

The distribution rules for a Rabbit Trust are determined by the Trust's specific terms and the employer's plan. And this is how trust works:

• First, the employer establishes the Trust with the help of a legal and financial advisor.
• Then, the employer contributes funds to the trust on behalf of its staff. Therefore, the schemes offered by the Rabbi Trust plan include deferred compensation plans, employee retirement plans, and other non-qualified employee benefit plans.
• The trustee manages the funds contributed to the trust, which are held separately from the employer's general assets.
• Moreover, the employees do not have access to the funds in the trust until certain conditions are met, such as retirement, disability, or other qualifying events.
• Additionally, the contributions made to the trust by the employer can be deducted as a business expense, subject to certain limitations and requirements under the tax code.
• Lastly, when the employees become eligible to receive the benefits, they are subjected to income tax on the amounts paid.

As a result, a well-drafted Rabbi Trust agreement is critical to ensuring that the entrust operates under applicable laws and regulations and provides the intended assistance to executives securely and efficiently.

Firms must understand the Rabbi Trust accounting & fundamental taxation regulations while drafting these trusts. It is because these trusts have some unique features not covered under the trust model of the IRS. Hence let us look at some essential taxation rules and their significance in the points below:

• The trust gets classified as a guarantor trust enabling the creditor to lay claim on it during bankruptcy.
• As a result, when an employee withdraws their funds from the trust, they will not be taxed on their deposits.
• Also, due to it, the trust offers tax-free growth of the funds for employees. 
• Therefore, the income received by the employee through the trust funds deposited by the employer will not be subject to additional income tax.
• An employer has to pay all the taxes related to the fund.
• Employers will have to report all the deposits and income of the trust to legal authorities.
• The trust must comply with the rules and regulations under Section 409A of the IRS, which governs the taxation of non-qualified deferred compensation plans.

Let us look at both sides of the trust in the table below:

Let us look at an example to clear our concepts. Suppose a company named Globex Corporation has top executives providing tremendous growth in its business, revenue, and brand reputation. The management does not want them to leave the company at any cost. Hence, they form a Rabbi Trust where the company will contribute five percent of the annual salary every quarter in the name of these executives.

The executive has a high-salary bracket of $150,000 annually. Therefore, they will receive an extra rabbi fund of $7500 quarterly in this trust fund. Hence their net annual salary would be $180,000. However, they would only pay the income tax on their annual salary of $150,000, not $30,000.

Thus, they would get a corpus of $300000 funds on their retirement besides the pension benefits and salary accumulation. Moreover, $300,000 would be taxed when they withdraw the funds from the trust. Therefore, one observes that the rabbi fund allows extra benefits and fund growth without tax liability as a supplementary pension on retirement.

The main difference between the Rabbi Trust and a Secular Trust is their purpose and governing laws that apply to them. The former is a non-qualified Trust allowing the employer to set aside funds to pay its employees. On the other hand, Secular Trust is a trust where the grantor transfers the assets to the trustee to be managed to benefit one or more beneficiaries.

This article has been a guide to what is Rabbi Trust. Here, we explain its taxation, pros and cons, comparison with secular trust, and its examples. You may also find some useful articles here -

• Clayton Antitrust Act
• Deed of Trust
• Discretionary Trust