Secular Trusts

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, once committed.
  • 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 plan participant.

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 once vested.

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.


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