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.
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How does Merck's new retirement benefits program support long-term financial security for employees, particularly regarding the changes to the pension and savings plans introduced in 2013? Can you elaborate on how Merck's commitment to these plans is designed to help employees plan for retirement effectively?
Merck's New Retirement Benefits Program: Starting in 2013, Merck introduced a comprehensive retirement benefits program aimed at providing all eligible employees, irrespective of their legacy company, uniform benefits. This initiative supports Merck's commitment to financial security by integrating pension plans, savings plans, and retiree medical coverage. This approach not only aims to help employees plan effectively for retirement but also aligns with Merck’s post-merger goal of standardizing benefits across the board.
What are the key differences between the legacy pension benefits offered by Merck before 2013 and the new cash balance formula implemented in the current retirement program? In what ways do these changes reflect Merck's broader goal of harmonizing benefits across various employee groups?
Differences in Pension Formulas: Before 2013, Merck calculated pensions using a final average pay formula which typically favored longer-term, older employees. The new scheme introduced a cash balance formula, reflecting a shift towards a more uniform accumulation of retirement benefits throughout an employee's career. This change was part of Merck's broader strategy to harmonize benefits across various employee groups, making it easier for employees to understand and track their pension growth.
In terms of eligibility, how have Merck's pension and savings plans adjusted for years of service and age of retirement since the introduction of the new program? Can you explain how these adjustments might affect employees nearing retirement age compared to newer employees at Merck?
Adjustments in Eligibility: The new retirement program revised eligibility criteria for pension and savings plans to accommodate a wider range of employees. Notably, the pension benefits under the new program are designed to be at least equal to the prior benefits for services rendered until the end of 2019, provided employees contribute a minimum of 6% to the savings plan. This adjustment aids both long-term employees and those newer to the company by offering equitable benefits.
Can you describe the transition provisions that apply to legacy Merck employees hired before January 1, 2013? How does Merck plan to ensure that these provisions protect employees from potential reductions in retirement benefits during the transition period?
Transition Provisions for Legacy Employees: For employees who were part of legacy Merck plans before January 1, 2013, Merck established transition provisions that allow them to earn retirement income benefits at least equal to their current pension and savings plan benefits through December 31, 2019. This ensures that these employees do not suffer a reduction in benefits during the transition period, offering a sense of security as they adapt to the new program.
How does employee contribution to the retirement savings plan affect the overall retirement benefits that Merck provides? Can you discuss the implications of Merck's matching contributions for employees who maximize their savings under the new retirement benefits structure?
Impact of Employee Contribution to Retirement Savings: In the new program, Merck encourages personal contributions to the retirement savings plan by matching up to 6% of employee contributions. This mutual contribution strategy enhances the overall retirement benefits, incentivizing employees to maximize their savings for a more robust financial future post-retirement.
What role does Merck's Financial Planning Benefit, offered through Ernst & Young, play in assisting employees with their retirement planning? Can you highlight how engaging with this benefit changes the financial landscapes for employees approaching retirement?
Role of Merck’s Financial Planning Benefit: Offered through Ernst & Young, this benefit plays a critical role in assisting Merck employees with retirement planning. It provides personalized financial planning services, helping employees understand and optimize their benefits under the new retirement framework. Engaging with this service can significantly alter an employee’s financial landscape by providing expert guidance tailored to individual retirement goals.
How should employees evaluate their options for retiree medical coverage under the new program compared to previous offerings? What considerations should be taken into account regarding the potential costs and benefits of the retiree medical plan provided by Merck?
Options for Retiree Medical Coverage: With the new program, employees must evaluate both subsidized and unsubsidized retiree medical coverage options based on their age, service length, and retirement needs. The program offers different levels of company support depending on these factors, making it crucial for employees to understand the potential costs and benefits to choose the best option for their circumstances.
In what ways does the introduction of voluntary, unsubsidized dental coverage through MetLife modify the previous dental benefits structure for Merck retirees? Can you detail how these changes promote cost efficiency while still providing valuable options for employees?
Introduction of Voluntary Dental Coverage: Starting January 2013, Merck shifted from sponsored to voluntary, unsubsidized dental coverage through MetLife for retirees. This change aligns with Merck’s strategy to promote cost efficiency while still providing valuable dental care options, allowing retirees to choose plans that best meet their needs without company subsidy.
How can employees actively engage with Merck's resources to maximize their retirement benefits? What specific tools or platforms are recommended for employees to track their savings and retirement progress effectively within the new benefits framework?
Engaging with Merck’s Retirement Resources: Merck provides various tools and platforms for employees to effectively manage and track their retirement savings and benefits. Employees are encouraged to utilize resources like the Merck Financial Planning Benefit and online benefit portals to make informed decisions and maximize their retirement outcomes.
For employees seeking additional information about the retirement benefits program, what are the best ways to contact Merck? Can you provide details on whom to reach out to, including any relevant phone numbers or online resources offered by Merck for inquiries related to the retirement plans?
Contacting Merck for Retirement Plan Information: Employees seeking more information about their retirement benefits can contact Merck through dedicated phone lines provided in the benefits documentation or by accessing detailed plan information online through Merck's official benefits portal. This ensures employees have ready access to assistance and comprehensive details regarding their retirement planning options.