I went to the University of Miami Law School at night while working in the life insurance industry. When I graduated and got admitted to the Bar in 1994, the legal market was dead and estate planning attorneys were recommending remaining in the life insurance industry. For better or worse, I never looked back (until now!).
The first article that I published professionally was an article on the use of offshore rabbi trusts. I went on to publish a few articles on this topic. The article was an academic exercise for me in something that I had an academic interest in but resulted in no commercial value to me. A few calls here and there but otherwise little or no attention.
I worked for Deloitte and Touche for a few years in the late 1990’s. I recall meeting a partner from the National Tax Office who had retired from the IRS as the chief of the employee benefits area. He asked me if I was the same “Nowotny” who had written the article on offshore rabbi trusts. I thought how nice that someone (besides me) read my article until I realized that it is not a good thing to be well known by Uncle Sam!
When Congress passed new legislation, IRC Sec 409A, restricting the use of offshore trusts in rabbi trust planning for non-qualified deferred compensation plans, my article was cited in the Congressional Record. Most people who know me personally know that I am little (read highly) disorganized. Of course, I don’t have a copy of my own article so when I “googled” my article, I saw it cited in a number of law review articles.
The moral of the Story- you may be smarter than your wife thinks you are but not as smart as your mother thinks you are. No! Rabbi trusts continue to be an important part of retirement planning for senior executives who are participants in non-qualified retirement plans.
This article addresses the use of Nevada asset protection trusts as an alternative in non-qualified deferred compensation planning using rabbi trusts. The article will also explore the use of Nevada as a preferred situs for Medicaid Income Only Trusts.
This article is an update of my old idea.
Non-Qualified Deferred Compensation Plans
Over the last twenty five years, non-qualified deferred compensation plans have proliferated in the private and public sector. Qualified retirement plans are frequently inadequate in addressing the retirement planning considerations of senior executives. Why?
First, many senior executives make a lot more money than the current $250,000 maximum salary for determining retirement plan contribution limits. Second, the maximum contribution limit for defined contribution limit is $49,000. Third, very few companies offer defined benefit retirement plans anymore. Fourth, the maximum retirement benefit under a defined benefit is $200,000 per year. Lastly, times are tough and companies are cheap. Pension plans are expensive because unlike non-qualified programs, they do not allow companies to carve-out a group of highly compensated executives.
Non-qualified deferred compensation plans come in several shapes and sizes. Supplemental executive retirement plans (SERPS); Top Hat Plans et all provide Employer contributions on an after-tax basis for the benefit of a group of highly compensated and select executives to supplement qualified plan benefits. 401(k) Mirror plans allow an executive to make a salary deferral in excess for the 401(k) qualified plan limits. The corporation uses after-tax dollar to informally fund these benefits. The executive does not have any income tax recognition until the benefits are paid to the executive.
The essential ingredients to make this function properly include the following in order for executives to avoid constructive receipt of benefits and current taxation:
(1) Unsecured promise to pay
(2) Plan assets subject to the claims of the Employer’s creditors if informally funded by Employer
IRC Sec 409A added some additional hoops to jump through. Elections to defer income must be made before the calendar year in which services are rendered. Distributions can’t be made until the earlier of separation of service; disability’ death; change in corporate control or unforeseen emergency. Acceleration of payments subject to a “haircut” is no longer permissible.
Rabbi Trusts and Offshore Rabbi Trusts
Rabbi Trusts have been used since 1980 when a Synagogue received a favorable private letter ruling (PLR8113107) for a benefit arrangement for the Temple’s Rabbi. The idea is that while the plan assets remain subject to the claims of the Employer’s creditors, the assets are placed out of the reach of the Employer in the event the Employer changes its mind.
The idea of an offshore rabbi trust that while assets remained legally subject to the claims of the employer’s creditors, the laws of the offshore jurisdiction made it difficult and cumbersome and expensive for the creditor to collector the assets. The likelihood is that creditors might be forced into to settlements with the Offshore Rabbi Trust at a very large discount or alternatively be unable to get a judgment against the Offshore Rabbi Trust let alone enforce a judgment from the U.S. Offshore jurisdictions with favorable legislation have several features that make it difficult for creditors – (1) Short Statute of Limitations (2 years from the time of transfer to the Trust). (2) Lack of Comity (no enforcement of foreign judgments) (3) British System (Loser pays) (4) High Standard of Poof (Beyond a Reasonable Doubt). Needless to say, it was a very effective solution for Rabbi Trusts
IRC Sec 409A eliminates the ability to use Offshore Trusts. The transfer of deferred compensation assets results in immediate taxation. The earnings are also taxed and a twenty percent excise tax applies.
Income only trust for Medicaid planning is permitted under OBRA-93. These trusts are customarily designed so that the grantor or the grantor’s spouse receives all of the income from the trust but has no access to trust principal. More states are broadening the definition of an “Estate” for Medicaid recovery purposes. As a result, these states could attempt to recover from the trust. The Nevada trust is effective for mitigating the potential claims of a state attempting to recover its costs under Medicaid.
Domestic Rabbi Trusts in Nevada
Nevada is one of thirteen states that have passed asset protection legislation allowing self-settled trusts. Nevada arguably has the strongest legislation. Importantly, new legislative changes under Nevada allow a trust sitused in a different jurisdiction to move its situs to Nevada without restarting the two year statute of limitations under Nevada law. Nevada trusts must have a trustee domiciled in Nevada. Nevada does not have any “excepted” creditors such as spouses and children. The statute of limitations is two years with respect to future creditors and existing tort creditors. The statute of limitations is shortened to six months for existing investors that were aware of the transfer to the Nevada Trust.; Nevada also has no state income tax.
The Nevada four year statute of limitations for most contractual claims does not supersede the two year statute of limitations for transfers to the Trust.
The Rabbi Strikes Back!
The fact that Plan assets in a non-qualified deferred compensation arrangement need to remain subject to the claims of the Employer’s creditors does not mean that the Creditor has to hold the Employer’s check book. The fact that a jurisdiction such as Nevada has favorable spendthrift provisions and a short statute of limitations along does not compromise the reality that the assets in the Nevada-domiciled Rabbi Trust remain subject to the Creditors.
In Rabbi Trust planning very serious consideration should be given to changing the domicile of Rabbi Trust to Nevada. The provisions of Nevada trusts are very favorable from an asset protection standpoint. The laws are the same whether an individual is a settlor of a trust or an Employer. The short statute of limitations and spendthrift provisions extend to the Settlor. The application of those rules to existing creditors is very favorable as well.
Similarly, Medicaid trusts should transfer the situs of the trust to Nevada. Importantly, under Nevada law the transfer of the trust situs to Nevada does not begin a new time period for statute of limitations purposes. An existing Medicaid trust can place a family in a much stronger defensive position to minimize the chances for success in estate recovery for Medicaid purposes.
The Nevada Rabbi provides powerful protection mechanism for Rabbi Trust assets that legally remain subject to the claims of creditors. These domestic trusts should not violate IRC Sec 409A. First, Nevada is not an offshore jurisdiction. Second, the Rabbi Trust provisions fit squarely within the provisions of the Nevada statutes.
Many large corporations may not be making new contributions to existing non-qualified deferred compensation plans, but should seriously consider re-domesticating their existing Rabbi Trusts to Nevada as soon as possible.
At the same time, families that have established Medicaid trusts for planning for the elderly should give immediate attentions towards changing the situs of the trust to Nevada.