A rabbi trust is a company-owned trust that can provide benefits to key employees. While rabbi trusts can help workers defer taxes, they can be a risky undertaking for smaller businesses.
Understanding Rabbi Trusts
Contrary to what many people believe, rabbi trusts have little to do with religion. While the first rabbi trust was established by a Jewish congregation that wanted to support its rabbi after he retired, these trusts are almost always established by businesses.
Rabbi trusts are often used to provide additional security to high-level executives and top-tier employees. When a company establishes a rabbi trust, they place deferred compensation into a separate trust. Since the compensation is administered by a third-party trustee, the business cannot recover deposited funds for future use.
Under most circumstances, rabbi trusts provide security for employees seeking to minimize their compensation to save money on taxes.
The Benefits of Rabbi Trusts
Companies are responsible for creating rabbi trusts. So long as the founding company is financially stable, a rabbi trust can keep deferred compensation and benefits safe from the Internal Revenue Service and creditors.
While employees must eventually pay tax on rabbi trust funds—when they retire or when they make a withdrawal—their money will typically remain protected until they begin receiving disbursements.
The Disadvantage of Rabbi Trusts
Rabbi trusts can help higher-earning employees minimize their tax burden. However, rabbi trusts have a significant disadvantage: while rabbi trust funds may be held by a third-party entity, the trust itself is not protected from creditor claims.
If the founding company declares bankruptcy or otherwise becomes insolvent, its creditors will have unbridled access to the rabbi trust’s funds—potentially depriving employees of their own earnings.
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