Rabbi Trust

[fidu]

Happy Holidays to all.

little help please . . .is a Rabbi Trust a DB or a DC type plan, and why?

[lkpittman]

Neither, really. A rabbi trust is established by an employer to provide a source of funds that can be used to satisfy the obligation to employees under one or more nonqualified plans (usually a "top hat" plan or SERP). The underlying plan is an "unfunded" plan and the assets in the trust are subject to the claims of the employer's creditor's. This is just a very simple explanation that only skims the top of the rabbi trust world. But a rabbi trust is not used in connection with a 401(k)--maybe you'll get some expert responses if you ask the question under a different forum (I'm not sure whether there a forum here for nonqualified plans?).

[fidu]

thanks lkpittman. can you clarify what you mean that the underlying plan is unfunded, but the trust does have money in it? im a bit confused.

much obliged.

hope you had a happy holiday weekend.

[Steve72]

To oversimplify, the trust is an asset of the employer's, not the plan's. It is used to offset the outstanding debt incurred by the employer in promising non-qualified deferred comp. The assets of the rabbi trust may be used by the employer to pay this debt, or to pay the employer's general creditors. There are no funds that are earmarked solely for use by the plan, thereofre the plan is unfunded.

[pjkoehler]

You should take a close look at Rev. Proc. 92-64. It lays out the IRS model rabbi trust and provides background information that would be helpful to anyone looking at these vehicles for the first time.

A rabbi trust is just a label for an employer's grantor trust. Under the grantor trust rules, the assets of the trust are capital assets of the grantor (employer), i.e. all of the dividends, interest and net realized gains flow through to the employer as taxable income currently. The model rabbi trust allows the grantor to restrict the use of the trust assets to the payment of the deferred comp plan benefits, EXCEPT THAT, the assets must be subject to the claims of the employer's general creditors in the event of the employer's insolvency. The employer may design a rabbi trust to afford the plan participants with maximum benefit security, without creating adverse tax consequences (i.e. avoid "funding" the plan) by including a provision that prohibits the employer from deploying the trust assets for any purpose other than the payment of plan benefits, UNLESS the employer has sought relief under state insolvency laws or filed a bankruptcy petition, in which case the participants have no greater claim to the trust assets than the employer's general creditors. Such a provision would give rise to a lawsuit for breach of fiduciary duty, if the trustee attempted to deploy the trust assets for any other purpose in the absence of the employer's insolvency.

As a practical matter, since the executives managing the plan are also well aware of the financial condition of the employer, they would typically just terminate the plan and distribute the assets to pay plan benefits resulting in current taxation to the executives. This may not be the desired tax result, but it's better than standing in line eventually with the general creditors.

P.S. An interesting side note: Enron did not terminate its nonqualified deferred compensation plans prior to filing its bankruptcy petition, leaving the affected executives in that very line.

[david rigby]

And you can find Revenue Procedure 92-64 here.

[fidu]

so the participants (executives) of a deferred comp plan would in Enron's case get screwed if there is nothing left at the end of the bankruptcy??

[pjkoehler]

Let's just say that the executives entitled to a distribution from an Enron nonqualified deferred comp plan at the time the company filed its bankruptcy petition will be treated like Enron's unsecured creditors. These benefit liabilities may well be discharged by the Bankruptcy court, or, at least, significantly diluted in terms of their potential value. I doubt these executives would take issue with your characterization.

[fidu]

many thanks once again for all the information and explanation.

see you on the message board again sometime soon.