A rabbi trust agreement is a type of non-qualified deferred compensation plan that is used by employers to attract and retain highly compensated executives. It is a contract between the employer and the executive, where the employer sets aside funds in a trust that is managed by a third-party trustee. The funds are then paid out to the executive at a later date, typically upon retirement or termination.
The term “rabbi trust” comes from a landmark case in 1980, where a New York rabbi sued his synagogue for breach of contract after they failed to make good on their promise to provide him with deferred compensation. The courts ruled in favor of the rabbi, and the use of rabbi trusts became widespread as a way for employers to provide deferred compensation while also protecting the funds from creditors in case of bankruptcy.
One of the key benefits of a rabbi trust is that the funds are not considered taxable to the executive until they are actually paid out. This can provide a significant tax advantage, especially for highly compensated individuals who are in a high tax bracket. Additionally, the funds are protected from creditors, which can provide peace of mind for executives who are concerned about the financial stability of their employer.
However, there are also some potential drawbacks to using a rabbi trust. One is that the funds are not actually set aside in a separate account, but are instead held by the employer until they are paid out. This means that the funds are still subject to the claims of creditors in the event of bankruptcy or other financial difficulties. Additionally, the use of a rabbi trust is subject to certain IRS regulations, and failure to comply with these regulations can result in penalties and other consequences.
Overall, a rabbi trust can be a valuable tool for employers who are looking to provide deferred compensation to highly compensated executives. However, it is important to carefully consider the potential benefits and drawbacks of this type of plan before deciding whether to implement it. Working with an experienced financial advisor and legal professional can help ensure that the plan is structured in a way that meets the needs of both the employer and the executive.