Secular Trust

Definition

A secular trust is a type of irrevocable trust arrangement commonly used in conjunction with nonqualified deferred compensation plans. It is designed to provide executives with enhanced security for their deferred compensation by ensuring that the assets held in the trust are not subject to the claims of the employer’s creditors. This offers more security compared to a Rabbi Trust, where trust assets remain accessible to the employer’s creditors in the event of insolvency.

Examples

Example 1: A company sets up a secular trust to hold deferred compensation for its CEO. The assets in the trust reside separately from the company’s general assets and cannot be seized by the company’s creditors if the company faces bankruptcy.
Example 2: An executive participates in a nonqualified deferred compensation plan funded by a secular trust. Because the assets are protected from the company’s creditors, the executive can be confident they will receive their deferred compensation irrespective of the company’s financial situation.

Frequently Asked Questions (FAQs)

Q: What is the main difference between a Rabbi Trust and a Secular Trust?
A: The primary difference is that while assets in a Rabbi Trust can be accessed by creditors in the event of the company’s insolvency, assets in a Secular Trust are protected from creditor claims, providing greater security to the executive.

Q: What types of plans typically use a Secular Trust?
A: Secular Trusts are typically used with nonqualified deferred compensation plans for executives and other highly compensated employees.

Q: Are there any tax implications for executives with assets in a Secular Trust?
A: Yes, under U.S. tax law, contributions to a Secular Trust are generally considered taxable to the executive when made, as it is considered their beneficial interest is secured.

Q: Can a Secular Trust be revoked once established?
A: No, a Secular Trust is irrevocable, meaning it cannot be revoked or altered once it has been established.

Q: Is there a downside to using a Secular Trust?
A: One potential downside is the immediate taxation of contributions to the trust, which can be less favorable compared to other options that may defer taxation.

Rabbi Trust: An irrevocable trust set up to hold deferred compensation for employees. Unlike a secular trust, these trust assets are accessible to company creditors in the event of insolvency.
Deferred Compensation Plan: A plan that allows employees to earn wages, bonuses, or other compensation in one period, but receive the payment in a later period, often upon retirement.

Online References

Suggested Books for Further Studies

“Executive Compensation Answer Book” by Mitchell M. Feder, who discusses various compensation strategies, including secular and rabbi trusts.
“Employee Benefits Design and Compensation (Collection)” by Bashker D. Biswas, which includes in-depth discussions on executive compensation and trust arrangements.
“Deferred Compensation: Meaning, Definition, and Examples” by Michael McCord, offering detailed coverage of deferred compensation mechanisms.

Fundamentals of Secular Trust: Executive Compensation Basics Quiz

### What is the primary feature that sets a secular trust apart from a Rabbi Trust? - [ ] Both trusts offer the same protection from creditors. - [x] A secular trust's assets are not subject to creditors' claims, whereas a Rabbi Trust's assets are. - [ ] A secular trust is easier to revoke compared to a Rabbi Trust. - [ ] A Rabbi Trust offers more tax advantages than a Secular Trust. > **Explanation:** The secular trust provides greater security for the executive because its assets are not subject to creditor claims in the event of the company's insolvency, whereas Rabbi Trust's assets are subject to such claims. ### Which of the following is a potential downside of a secular trust? - [ ] The trust is irrevocable. - [ ] Immediate taxation of contributions to the trust. - [ ] The trust requires more complex administration. - [x] All of the above. > **Explanation:** Potential downsides of a secular trust include immediate taxation upon contributions, its irrevocable nature, and potentially more complex administration. ### What type of executive plan commonly uses a secular trust? - [ ] Qualified retirement plans. - [x] Nonqualified deferred compensation plans. - [ ] Health savings accounts. - [ ] Equity option plans. > **Explanation:** Secular trusts are commonly used in conjunction with nonqualified deferred compensation plans, which are designed to provide tailored benefits for executives. ### Are contributions to a secular trust taxable to the executive? - [x] Yes, contributions are taxable when made. - [ ] No, contributions are only taxable when withdrawn. - [ ] Contributions are not subject to taxation. - [ ] Taxation depends on the type of contributions. > **Explanation:** Under U.S. tax law, contributions to a secular trust are taxable to the executive at the time they are made, as their beneficial interest in the trust is secured. ### Can a secular trust be revoked or altered once established? - [ ] Yes, it can be revoked any time. - [x] No, it is irrevocable. - [ ] It depends on the company's policy. - [ ] It requires approval from the IRS. > **Explanation:** Once a secular trust is established, it is irrevocable and cannot be unilaterally revoked or altered. ### What happens to the assets in a secular trust if the company goes bankrupt? - [ ] The assets are returned to the company. - [ ] Creditors gain access to the assets. - [x] The assets remain protected and are secured for the executive. - [ ] The government claims the assets. > **Explanation:** One of the key advantages of a secular trust is that the assets are protected from the company's creditors in the event of bankruptcy, ensuring security for the executive. ### Why might an executive prefer a secular trust over a Rabbi Trust? - [ ] Lower administrative costs. - [ ] Easier to set up and revoke. - [x] Greater security as assets are protected from creditors. - [ ] Offers more investment options. > **Explanation:** An executive may prefer a secular trust because it provides greater security, with trust assets being protected from the company's creditors. ### How does the Internal Revenue Service (IRS) treat contributions to a secular trust? - [x] As taxable income to the executive at the time of contribution. - [ ] As nontaxable until withdrawal. - [ ] As fully deductible by the company. - [ ] The IRS does not regulate these contributions. > **Explanation:** The IRS treats contributions to a secular trust as taxable income to the executive at the time of contribution because the beneficial interest of the executive in the trust is secured. ### What advantage does a secular trust offer to an executive in a nonqualified deferred compensation plan? - [ ] An immediate higher take-home pay. - [ ] Flexible withdrawal options. - [x] Assurance that the deferred compensation will be paid out even if the employer faces financial difficulties. - [ ] No need for regular contributions. > **Explanation:** A secular trust provides the executive an assurance that deferred compensation will be paid even if the employer faces financial difficulties, as the assets are protected from the employer's creditors. ### In which scenario would a secular trust not be beneficial for an executive? - [ ] The executive wants immediate access to the funds. - [ ] The company is financially stable and has no risk of insolvency. - [ ] The executive is looking for tax deferral on the contributions. - [x] All of the above. > **Explanation:** A secular trust might not be beneficial if the executive is seeking immediate access to funds, tax deferral, or if the company is highly stable and has no risk of insolvency.

Thank you for learning with us about secular trusts. We hope you find this information valuable for managing executive compensation and understanding the differences between various trust arrangements. Keep striving for excellence in your financial and executive compensation knowledge!