A “rabbi trust” is a retirement plan used by some churches to set aside funds for an employee’s retirement. Rabbi trusts typically are created for a senior pastor who is approaching retirement. One of the advantages of a rabbi trust is that the annual contribution limits that apply to tax-sheltered annuities and qualified pension plans do not apply. This allows churches to set aside more substantial amounts for a minister’s retirement.
The IRS has ruled that amounts set aside by employers in a rabbi trust on behalf of an employee are not currently taxable to the employee so long as certain requirements are met. One requirement is that the trust is subject to a “substantial risk of forfeiture.” A “substantial risk of forfeiture” includes making the funds set aside in a rabbi trust subject to the employer’s general creditors. A federal appeals court addressed this aspect of rabbi trusts in a recent case.
A company filed for bankruptcy protection, listing among its assets a substantial amount set aside in a rabbi trust for one of its officers. The company’s secured creditors insisted that the entire trust was an asset of the bankruptcy court that should be distributed to them since their security agreement included all “intangible personal property of every kind and nature.” The court agreed that this language was broad enough to include a rabbi trust, but it concluded that the creditors had no right to the trust fund. It noted that the company had based its rabbi trust on “model trust” language adopted by the IRS which only makes trust funds subject to general creditors of the employer. As a result, the court ruled that the company’s secured creditors had no right to funds in the rabbi trust, even though their security interest extended to all “intangible personal property of every kind and nature.”
In summary, according to this court, funds set aside in a rabbi trust based on the IRS “Model Rabbi Trust Agreement” are subject to the general or unsecured creditors of the church, but not the secured creditors. This is true even if a secured creditor’s security interest applies to “intangible personal property of every kind and nature.” The court noted that there is no reason, in principle, why a creditor could not secure a loan to a church with a security interest in funds set aside in a rabbi trust. But, this would require a modification in the model trust language drafted by the IRS. Bank of America v. Moglia, 330 F.3d 942 (7th Cir. 2003).
Resource. The IRS Model Rabbi Trust Agreement is set forth in Chapter 10, Section N, of Richard Hammar’s Church & Clergy Tax Guide. Rabbi trusts are discussed generally in Chapter 10, Section E.