Definition
A Rabbi Trust is a type of trust established by a company to set aside assets for fulfilling obligations of specific benefit plans, such as pension plans or deferred compensation. It’s termed a “Rabbi Trust” because it was first used by a Jewish organization for its Rabbi. Assets in a Rabbi Trust are secure from creditors, except in insolvency or bankruptcy.
Key Takeaways
- “Rabbi Trust” refers to a type of trust created by companies to support their nonqualified benefit promises to employees. It gains its name from the fact that the first IRS letter of approval endorsing this approach was granted to a rabbi.
- The assets in a Rabbi Trust remain part of the employer’s general assets until delivered to the employee. Thus, they are subject to the claims of the employer’s creditors until actually paid out to the participant.
- One significant upside to a Rabbi Trust for an employee is that it provides them with security that the nonqualified benefits will be available to them in the future, even if the employer experiences financial difficulties or changes in management.
Importance
A Rabbi Trust is a crucial finance term as it represents an irrevocable trust arrangement that companies use to secure non-qualified deferred compensation plans.
Since companies cannot access the funds within this trust to satisfy creditors or for other business operation purposes, it offers security for employees or beneficiaries, ensuring their deferred compensation is available regardless of the company’s financial state.
However, it gained its name because the first trust of this type received a favor (nontaxable) ruling from the IRS based on a request by a Jewish (Rabbi) congregation.
It offers tax advantages for companies while providing a layer of protection to beneficiaries in case the company goes bankrupt, merging its financial benefits with risk management.
Explanation
A Rabbi Trust serves as a secure funding vehicle for a firm’s deferred compensation programs. It is established by employers as a means for funding non-qualified benefits.
These trusts are believed to provide assurance to employees that their deferred compensation will be paid even if a company encounters financial difficulties or changes in ownership or control. This sort of trust is primarily used by companies to reserve assets for the fulfilment of future obligations related to their compensation and benefits plans.
In essence, Rabbi Trusts serve as a protection mechanism, safeguarding employees’ deferred compensation. The assets placed into the trust are removed from the employer’s balance sheet, thereby assuring employees that their deferred compensation is out of the reach of the company’s creditors.
However, these reserved assets would still be subject to company creditors in the event of bankruptcy, in keeping with the provisions of the Employee Retirement Income Security Act (ERISA). This acts as a middle ground, ensuring that employees will receive their deferred compensation under common circumstances, while not completely divorcing it from the fate of the company.
Examples of Rabbi Trust
Executive Retirement Plans: A major corporation may establish a Rabbi Trust for its executives. This is to ensure that their non-qualified deferred compensation benefits are secured, even if the company goes bankrupt. An example here could be FedEx setting up a Rabbi Trust plan to secure the retirement benefits of its top executives.
Divorce Settlements: In some high profile divorce cases, one party may set up a Rabbi Trust in the name of the other spouse. This ensures that there would be enough funds to cover alimony payments or child support. For instance, a celebrity might establish a Rabbi Trust and put enough money in there to cover all future alimony payments during a divorce settlement.
Sports Contract Payment: In professional sports, some teams establish Rabbi Trusts to guarantee the promised contract payments to their athletes in case the team suffers a financial downturn or bankruptcy. For instance, a major league football team signed a new star player to a multi-year contract could use a Rabbi Trust to ensure that they could meet the yearly salary obligations, regardless of the team’s financial situation in the coming years.
Rabbi Trust FAQ
What is a Rabbi Trust?
A Rabbi Trust is a type of trust set up by an employer to set aside funds for deferred compensation plans or for employee benefit plans. This type of trust gets its name because the first time the IRS approved its use was for a deferred compensation plan established by a rabbi. In a Rabbi Trust, the trust assets are subject to the claims of the company’s creditors, offering the employees some protection.
How is a Rabbi Trust different from a secular trust?
Unlike a secular trust, in a Rabbi Trust, the assets are still within reach of the employer’s creditors. In case the company goes bankrupt, the Rabbi Trust assets can be used to pay off creditors. Meanwhile, in a secular trust, the assets are completely secured and out of reach of both employers and their creditors.
Where does the name Rabbi Trust come from?
The name ‘Rabbi Trust’ comes from the first letter ruling made by the IRS for such an arrangement, which was done for a deferred compensation plan established for a rabbi, therefore, the plans earning the name ‘Rabbi Trust’.
What are the benefits of a Rabbi Trust?
The primary benefit of a Rabbi Trust is that it provides security to employees regarding their deferred compensation. If the company faces any financial trouble, the assets cannot be used for anything other than paying off the deferred compensation for employees. However, the assets will be available to creditors in the event of bankruptcy.
What are the potential limitations or downsides of a Rabbi Trust?
The downsides of a Rabbi Trust are that if the company goes bankrupt, the trust’s assets can be claimed by the company’s creditors. Essentially, the assets in a Rabbi Trust are not completely protected in all scenarios.
Related Entrepreneurship Terms
- Beneficiary
- Funded Trust
- Deferred Compensation Plan
- Non-Qualified Plan
- IRS (Internal Revenue Service)
Sources for More Information
Sure, below are four reliable sources where you can find more information about the term “Rabbi Trust”:
