What Is It?
A rabbi trust is a trust that you establish in order to informally fund your obligation to provide your employees with benefits under a nonqualified deferred compensation (NQDC) plan. It's called a rabbi trust because a rabbi was the beneficiary of the first such trust to receive a favorable IRS ruling. The primary reasons for establishing a rabbi trust are to provide your employees with assurance that assets will be available, and that payment of the deferred compensation will be made when payment is due under the terms of the NQDC plan. The trust provides a degree of security for your employees' deferred compensation by holding the plan assets apart from the corporation. By segregating sufficient funds in a rabbi trust, you will avoid the possible financial strain of having to pay a large amount of deferred compensation whenever the payment is due, and at the same time, will obligate the trustee of the rabbi trust (who is normally independent of the employer) to pay the deferred compensation from the trust assets when payment is due under the terms of the NQDC plan.
Caution: Although the rabbi trust assets are held apart from the corporation's assets, the rabbi trust assets are still subject to claims of the corporation's creditors, and benefits may be lost in the event of the employer's insolvency or bankruptcy.
Tip: A rabbi trust can be in the form of either a revocable or irrevocable trust (or a revocable trust that becomes irrevocable upon the occurrence of a certain event, for example, a change in control of the employer). If a rabbi trust is irrevocable, the employer gives up the use of the NQDC plan assets and can't get them back until all benefit obligations under the plan are satisfied. The assets are there to provide the NQDC benefits to your employees, except in the case of either a bankruptcy or insolvency. If bankruptcy or insolvency occurs, rabbi trust assets become accessible to your general creditors.
How Do You Establish A Rabbi Trust?
You as settler or grantor establish a rabbi trust by entering into a trust agreement with a trustee (usually a bank or trust company). The trustee then holds the NQDC plan contributions and investment earnings.
Tip: A single rabbi trust can benefit more than one employee.
Why Should You Establish A Rabbi Trust?
A rabbi trust is a major step forward in providing benefit security for plan participants. An irrevocable rabbi trust, coupled with placement of sufficient assets into the trust, can largely eliminate the risk of nonpayment for every reason except your bankruptcy or insolvency. For employees who worry about nonpayment primarily by reason of a hostile takeover or a similar occurrence ('change in control'), or where the employer refuses to pay ('change of heart'), an irrevocable rabbi trust is an ideal device. If nonpayment as a result of your insolvency or bankruptcy is your employees' primary concern, however, you may consider formally funding your NQDC plan with a secular trust or secular annuity.
Model Rabbi Trust
The Internal Revenue Service (IRS) has created safe harbor language in the form of a model rabbi trust that demonstrates how to structure a trust in order to achieve tax deferral of NQDC benefits. This model trust contains certain language that must be adopted as is, as well as optional provisions and language that can be modified as long as the changes aren't inconsistent with the suggested model trust language. The IRS will not issue favorable rulings on any rabbi trust that doesn't conform to the model trust language. For more information on the model trust provisions, see Revenue Procedure 92-64.
Tip: The creation of the rabbi trust doesn't cause the plan to be considered 'funded' for the purposes of the Employee Retirement Income Security Act of 1974 (ERISA).
Tip: You may wish to follow the model rabbi trust language in order to be sure that your trust arrangement will effectively defer taxation for your employees. What happens if you don't follow the model in setting up your rabbi trust? If challenged by the IRS, you may have to prove to the IRS that your plan is not funded for tax purposes. You can establish and operate a NQDC plan with a rabbi trust without applying for a favorable IRS ruling (this is common).
Tip: The model trust contains optional provisions that allow you to customize the trust to meet your and your employees' needs. For example, Revenue Procedure 92-64 permits 'springing' rabbi trusts, that is, a rabbi trust that has little or no assets until a triggering event occurs (for example, a change in control of the employer).
Federal Income Tax Treatment of Rabbi Trusts
Employee
The funds held in a properly designed rabbi trust are generally includable in the gross income of your employee when the NQDC plan benefits are paid to the employee.
Caution: However, the IRS may tax an employee on contributions made to a NQDC plan prior to the receipt of plan assets under the doctrine of constructive receipt (which requires taxation when funds are available to the employee without substantial restrictions), the economic benefit doctrine, or in the event the NQDC plan fails to meet the requirements of IRC section 409A.
Employer
Because the rabbi trust is a grantor trust and you, the employer, are the grantor, the IRS treats you as the owner of the trust for tax purposes. As a result, you must include the rabbi trust income, deductions, and credits when you calculate your tax liability.
Corporate-owned life insurance (COLI) is often used as a funding vehicle because cash values accumulate on a tax-deferred basis (unless the alternative minimum tax (AMT) rules apply), and upon your employee's death you receive the life insurance proceeds tax free.
You can deduct rabbi trust contributions in the year benefits under the plan and trust are includable in the gross income of your employees. Generally, this means that you will be able to take the deduction when your employee actually receives the NQDC plan benefits. Deductions are permitted only to the extent that such amounts constitute ordinary and necessary business expenses.
Tip: You can deduct the full amount paid to a participant (contributions plus investment earnings).
Risks and Costs Associated With Rabbi Trusts
There are risks and costs associated with rabbi trusts. The creation and maintenance of a rabbi trust often results in an increase in legal and administrative costs. You are subject to tax on the trust's investment income (corporate-owned life insurance is often used as a rabbi trust investment to avoid current taxation). In addition, if the trust is irrevocable, you won't have access to the trust assets, and you can't use the assets in the case of a corporate emergency or opportunity. Also, the trust assets aren't protected in the case of your insolvency or bankruptcy.
Internal Revenue Code (IRC Section 409a)
IRC Section 409A, enacted as part of the American Jobs Creation Act of 2004, contains funding rules that apply to rabbi trusts. Under Section 409A, if a rabbi trust invests in offshore assets, or if the trust may become funded as a result of a trigger based on the employer's financial health, then NQDC plan benefits are generally subject to federal income tax and penalties when they vest (i.e., when they are no longer subject to a substantial risk of forfeiture). Again, this may be prior to the time the employee is entitled to receive payments from the plan. If you maintain, or are considering adopting, a NQDC plan informally funded with a rabbi trust, you should consult a pension professional regarding the application of this important law.
Featured Video
Articles you may find interesting:
- Corporate Employees: 8 Factors When Choosing a Mutual Fund
- Use of Escrow Accounts: Divorce
- Medicare Open Enrollment for Corporate Employees: Cost Changes in 2024!
- Stages of Retirement for Corporate Employees
- 7 Things to Consider Before Leaving Your Company
- How Are Workers Impacted by Inflation & Rising Interest Rates?
- Lump-Sum vs Annuity and Rising Interest Rates
- Internal Revenue Code Section 409A (Governing Nonqualified Deferred Compensation Plans)
- Corporate Employees: Do NOT Believe These 6 Retirement Myths!
- 401K, Social Security, Pension – How to Maximize Your Options
- Have You Looked at Your 401(k) Plan Recently?
- 11 Questions You Should Ask Yourself When Planning for Retirement
- Worst Month of Layoffs In Over a Year!
How does the transition from the Solar Plan to the Caterpillar Inc. Retirement Income Plan impact current or former employees of Caterpillar Inc. in terms of retirement benefits and service credits? Considering both plans' differences, what aspects should employees of Caterpillar Inc. understand to ensure they are maximizing their retirement benefits under this merged structure?
Transition from Solar Plan to Caterpillar Inc. Retirement Income Plan: The transition from the Solar Plan to the Caterpillar Inc. Retirement Income Plan maintained the benefits of those previously covered under the Solar Plan without impact. Both plans allowed the continuation of prior service credits and the incorporation of benefits payable under previous retirement plans. For current or former employees, understanding the nuances of how prior service credits and benefits are integrated can maximize their retirement benefits under the merged structure.
What specific criteria must Caterpillar Inc. employees meet to qualify for early retirement and what implications does this have on their pension benefits? For employees planning early retirement, what calculations or benefit reductions should they be prepared for according to Caterpillar Inc.’s policies?
Criteria for Early Retirement at Caterpillar Inc.: Employees wishing to take early retirement must meet specific age and service requirements detailed in the plan documents. For early retirement, benefits calculations and potential reductions are significant. Employees need to prepare for possible reductions in their pension benefits depending on their age and years of credited service at retirement.
In the context of the Pension Equity Plan (PEP) and the Traditional Pension Plan, how do the benefit calculations differ for employees at Caterpillar Inc., particularly for those who switched from the Traditional Plan to the PEP? What considerations should current Caterpillar Inc. employees take into account when evaluating which plan may offer them more secure benefits?
Differences Between PEP and Traditional Pension Plan: The benefit calculations for the Pension Equity Plan (PEP) and the Traditional Pension Plan differ significantly. PEP calculates a lump sum based on salary and years of service, while the Traditional Plan calculates benefits based on final earnings or credited service formulas. Employees need to consider which plan offers more secure benefits based on their individual career trajectory and earnings history.
What steps must Caterpillar Inc. employees take to ensure that their Credited Service is accurately calculated and maintained throughout their employment, especially in light of the company's policies regarding breaks in service? How might phases of employment, such as parental leave or temporary positions, affect this calculation?
Credited Service Calculation and Maintenance: To ensure accurate credited service calculation, employees must maintain thorough records and communicate any changes in employment status, such as breaks in service or changes in personal information, to the plan administrator. Understanding the rules for service credits during different phases of employment, such as parental leave or temporary positions, is crucial.
How can employees at Caterpillar Inc. file a claim for benefits under the retirement plans, and what are the essential details they need to provide to ensure their claims are processed smoothly? If they encounter issues or denials, what recourse do they have within the Caterpillar Inc. system to appeal these decisions?
Filing a Claim for Benefits: Employees should provide detailed and accurate information when filing a claim for benefits under the retirement plans. If issues or denials occur, they have the right to appeal these decisions. Familiarity with the claims procedure and required documentation can streamline this process.
For employees approaching retirement, what resources are available through Caterpillar Inc. to help them navigate the complexities of their retirement benefits? What steps should an employee take if they wish to understand their benefits better or need assistance with retirement planning?
Resources for Navigating Retirement Benefits: Caterpillar Inc. offers resources to assist employees in navigating the complexities of their retirement benefits. Employees approaching retirement should utilize these resources and may need to engage with the company's human resources or benefits departments for personalized assistance.
What are the implications of the changes to the cash-out limit for de minimis benefits at Caterpillar Inc., which will take effect after December 31, 2023? How does this change affect employees who may have a vested interest in understanding their financial benefit options upon termination or retirement?
Implications of Cash-Out Limit Changes: The increase in the cash-out limit for de minimis benefits affects how small vested benefits are processed upon termination or retirement. Employees with small benefit amounts should understand how these changes may impact their options and tax implications.
How does Caterpillar Inc. ensure that its pension benefits are protected from creditors, and what specific provisions exist to safeguard these benefits? Moreover, how do legal instruments like Qualified Domestic Relations Orders (QDROs) interact with Caterpillar Inc.'s benefits system for employees undergoing divorce?
Protection of Pension Benefits from Creditors: Caterpillar Inc.'s retirement plans are designed with protections to safeguard benefits from creditors, including adherence to Qualified Domestic Relations Orders (QDROs) during instances like divorce. Employees should understand how these legal instruments can affect their retirement savings.
In what ways does the Caterpillar Inc. Retirement Income Plan provide coverage for disability retirement, and how is this benefit calculated for employees? What factors influence eligibility and how do employees initiate claims if they find themselves in need of these benefits?
Disability Retirement Coverage: The plan provides specific provisions for disability retirement, including how benefits are calculated and eligibility criteria. Employees should be aware of how disability affects their benefits and the process for initiating claims if needed.
How can Caterpillar Inc. employees contact the company to learn more about their retirement benefits, and what information should they have ready when making inquiries? Additionally, what specific departments at Caterpillar Inc. should employees reach out to for the most efficient assistance regarding their retirement plan questions?
Contacting the Company for Retirement Benefit Information: Employees can contact the Caterpillar Benefits Center for inquiries about their retirement benefits. Knowing the specific departments to contact for efficient assistance is crucial for addressing concerns and making informed decisions about retirement planning.