Rabbi Trust

A rabbi trust is a non‑qualified employee trust employers set up to fund promised deferred compensation or other supplemental benefits. The name traces to an early Internal Revenue Service private letter ruling involving a rabbi and his congregation. It’s designed to provide employees—typically senior executives—with greater assurance that promised benefits will be paid, while leaving the funds accessible under certain conditions.

Key takeaways

• A rabbi trust funds non‑qualified deferred compensation and similar promises to employees.
• Contributions and earnings are generally tax‑deferred for employees until distribution.
• The trust offers protection from the employer’s unilateral withdrawal or alteration, but not from the employer’s creditors in bankruptcy.

How a rabbi trust works

• Employer establishes the trust and funds it with cash, securities, or other assets earmarked for specific beneficiaries.
• The trust is typically structured so the employer cannot casually withdraw contributions or change the arrangement’s terms.
• For employees, contributions to the trust are not included in taxable income when made; taxation occurs when benefits are actually distributed.
• Example: An employee with $100,000 salary whose employer contributes $1,000 per month to a rabbi trust would still report $100,000 as current taxable income; the $12,000 contributed is taxed only when distributed.

Protections and limitations

• Protection: The trust prevents the employer from taking assets back to meet ordinary operating needs or from unilaterally changing the trust’s structure once established. A successor company generally cannot alter the trust terms either.
• Limitation: A rabbi trust does not protect assets from the employer’s creditors. If the employer becomes insolvent or files for bankruptcy, trust assets can be claimed by creditors as part of the employer’s estate.
• In short, a rabbi trust provides assurance that assets won’t be repurposed by the employer in normal circumstances, but it is not a safe harbor against bankruptcy claims.

Tax treatment

• Employees: Contributions and income earned inside the trust are tax‑deferred. Taxes are owed when distributions are made to beneficiaries.
• Employers: Establishing a rabbi trust typically does not produce the same tax benefits available from qualified retirement plans.

Who typically uses a rabbi trust?

• Employers offering supplemental compensation arrangements—especially deferred compensation—for key executives or high‑level employees commonly use rabbi trusts to signal commitment to future payments.

Common questions

Q: Do employees pay tax on contributions immediately?
A: No. Contributions are generally not included in the employee’s taxable income until distribution.

Q: Can an employer change or revoke a rabbi trust?
A: The trust is normally structured so the employer cannot unilaterally change its terms once established, and a successor owner typically cannot alter it either.

Q: Are assets in a rabbi trust safe if the company goes bankrupt?
A: No. In bankruptcy, trust assets are available to the employer’s creditors.

Bottom line

A rabbi trust is a useful tool for funding and signaling commitment to non‑qualified benefits, offering employees tax deferral and some protection from employer changes. However, because the trust’s assets remain vulnerable to creditors if the employer fails, it is not as secure as a fully separated, creditor‑proof vehicle. Employers and employees should weigh the tax advantages and the bankruptcy exposure when considering a rabbi trust.