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Secular trusts.
The term "secular" is used to distinguish this kind of trust from a rabbi trust. A secular trust is also a type of nonqualified deferred trust that is funded to compensate executives and key employees.
Here’s the major distinction between secular and rabbi trusts:
An employer’s bankruptcy creditors cannot access the money held in a secular trust like they can in a rabbi trust.
Taxes: An employer’s contributions to a secular trust, and the trust’s earnings, are considered taxable income to the executive or key employee upon vesting. Usually, the benefit’s after-tax value is funded from the secular trust and then the employee is given an additional bonus to cover the income tax consequences of the trust funds. Once contributions are taxed, later distributions to the employee (from already taxed contributions) are tax-free.
The employer is allowed a tax deduction for contributions when they are taxable to the employee or when the contributions become vested.
Double taxation is a problem in secular trusts.
- The secular trust pays income tax on undistributed income.
- The executive beneficiaries also pay income tax on the increased vested account balances that are attributable to the secular trust’s undistributed income.
This should be factored into any arrangement made between an employer and employee when a secular trust is involved.
Many employers “gross up” (increase the amount of) vested secular trust benefits to cover the tax due on trust contributions.
Exercise Question
A secular trust differs from a rabbi trust in that secular trust assets are: