Overview and Purpose
A secular trust is an irrevocable
trust, usually established by the employer, that holds assets
to be used for the exclusive purpose of providing funds for
the payment of nonqualified benefits. The establishment of
the secular trust provides additional security to participants
over and above the rabbi trust, in that the assets in a
secular trust are not subject to the claims of creditors.
However, establishing a secular trust fundamentally changes
the benefit structure as immediate taxation results.
Typically, the after-tax value of a benefit is funded within a
secular trust and the participating executive is generally
provided additional bonus monies to satisfy the income tax
consequences of the security established.
Thus, the security given is protection against :
- Change of heart: The employer cannot access assets in the trust,
- Change of control: An unfriendly takeover will not affect the
assets in the trust.
- Creditors and bankruptcy: Assets are beyond
the reach of creditors.
The price one pays for placing the assets beyond the reach of creditors
is that once vested, amounts set aside for a participant are fully
taxable. Since a secular trust is essentially an after tax arrangement,
the economics must be weighed against the extra security provided to the
Secular Trusts and ERISA
Secular trusts are fully subject to Title I of ERISA, which
includes the following requirements:
- Reporting and Disclosure
- Participation and Vesting
- Fiduciary Standards
- Administrative and Enforcement Provisions
The use of a Nonqualified Deferral Plan (NQDP) with a secular
trust will certainly involve a number of (possibly burdensome)
administrative requirements that rabbi trusts avoid.
The Secular Trust and the IRS
Employee Consequences: Since the
assets in the trust are for the sole benefit of participants,
and are beyond the reach of creditors, the participant will be
taxed once he becomes vested in his account balances
(contributions and earnings), under the Economic Benefit Doctrine.
To minimize the burden for participants, employers often
provide a bonus to cover the tax owed. A common alternative
procedure is to have the secular trust set up to directly
distribute an amount to cover the tax owed.
Employer Consequences: The employer may deduct contributions to
the trust, once they become vested to the employee.
Secular trust earnings issues are quite complex. If the secular
trust is set up as an employer grantor trust, trust income will
be taxed to the employer, without a corresponding deduction. This will
result in double taxation, since the employee will be taxed on the earnings
An alternative is setting up the trust as an employee grantor trust;
trust earnings will only be taxed once, at the participant level and not
the trust level.