Not just for rabbis, this trust punches above its weight to save small business owners money.

Successful small business owners stand to enter the generational wealth category with smart planning and this niche tax savings plan.

The rabbi trust is a special take on the non-qualified deferred compensation plan (NQDC). It takes the benefits of a NQDC plan and protects further. It is useful to the individual when corporate tax rates are lower than personal income tax rates.

English, please: The rabbi trust loosens the shackles on how much money you can contribute before taxes into an investment account and protects it while grows. Imagine a bigger garden with a taller fence.

They said it: “It’s dynamic. It can be a useful tool to transfer wealth from the business to an individual with lower taxes than other strategies.”

– Ben Abitz, Matt Logan Inc. Financial Planner

How it works: Rabbi trusts are set up between companies and individuals. Like a non-qualified deferred compensation plan, rabbi trusts:

  • Allow the individual’s money to grow tax-free. All capital gains taxes are paid for by the company.
  • Defer taxes for the individual and the taxes are not written off by the company until later
  • Have no limits on how much the company can contribute to the account, which benefits the individual

Unlike the non-qualified deferred compensation plan, rabbi trusts:

  • Are protected from the company. This means if the company is in financial troubles, they cannot use rabbi trust money to dig themselves out.

Okay, but how: With a rabbi trust, the beneficiary is the individual employee, not the company. The company, in rabbi trusts, are the grantor.

This allows the company to put money into the trust, and the employee doesn’t pay taxes on it. Additionally, any taxes on growth are paid by the company.

Those tax savings are a major bonus for the employee over the course of the trust when compared to a taxable account.

Take a rabbi trust vs. a hypothetical taxable account.

Let’s say an employee put $200,000 into both hypothetical accounts every year for 10 years. If we assume the employee is in the highest tax bracket, each year, the employee will have roughly a $74k less to contribute to the hypothetical taxable account.

In the rabbi trust, the $200k would not be counted as income. Instead of the account growing by $126,000 each year, the employee would be able contribute the full $200k. Over the course of a decade, that would make a $1M difference, assuming annual 6 percent growth on a portfolio.

When the employee retired, because the rabbi trust is tax deferred and has $1M more in the account. If the employee distributed $150k per year in after tax dollars, the rabbi trust would last an estimated 9 more years than the taxable account.

Fun Fact: The person who came up with the rabbi trust was, get this, a literal rabbi. In 1980, Anthony Manzanares, Jr. pitched this retirement savings plan to the IRS using a Private Letter Ruling, and it was approved! PLR 8113107 became known as the rabbi trust.

Successfull small business owners, depending on situation, are in a good place to explore the possibility of utilizing a rabbi trust. The straw that stirs the rabbi trust drink is corporate tax rates remaining lower than personal income tax rates.

For a comprehensive review of your personal situation, always consult with a tax or legal advisor. Neither Cetera Advisor Networks LLC nor any of its representatives may give legal or tax advice

Some of the content provided by Matt Logan Inc. is produced by Oechsli, a non-affiliate of Cetera Advisor Networks LLC.

Matthew Logan CFP®, AIF®

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Hypothetical Illustrations disclosure from section 12.25 of the Communications with the Public Guidelines: “The hypothetical investment results are for illustrative purposes only and should not be deemed a representation of past or future results. Actual investment results may be more or less than those shown. This does not represent any specific product or service.”.