With non-qualified benefits, employers add a valuable element to their overall executive compensation and benefit package. The trade-off for executives is risk. Since employers cannot legally fund benefits, participants are vulnerable to company takeover, management change of heart and company insolvency. Yet, there are ways to add security to non-qualified plans.

Rabbi Trust
The most widely accepted security device used to assure executives that future benefits will be paid is the rabbi trust. The goal of the rabbi trust, so named because it was first used by a congregation for its rabbi, is to guarantee benefit payment in the event of management change of heart or change of control, without current income taxation to executives. The employer sets up this grantor trust, determines benefit liabilities, and funds the rabbi trust. Tax consequences and any excess funding flow back to the employer. Because the company’s general creditors can still reach the assets, the participants are not taxed on trust earnings. At a specified triggering event (management change of heart or company change of control), the trust becomes responsible for benefit payments.

Using COLI, rather than other company assets, to fund a rabbi trust, offers a company several advantages. First, specific cash assets (COLI) can be set aside without impairing operations by tying up hard assets. Second, COLI is a tax-sheltered investment vehicle. Therefore, the initial contribution required is smaller than that using a taxable investment. Third, since there is a single opportunity to adequately fund the trust, COLI prevents the need to stockpile cash to compensate for the trustee's use of a conservative investment strategy, or the uncertain timing of death benefit liabilities. Finally, a trust funded with COLI requires a reduced level of active fund management, resulting in lower management fees and transaction costs.

In the event the corporation refuses to pay the legal benefits due, the trustee of the rabbi trust is authorized to surrender the COLI policies to raise funds to pay benefits. This surrender will result in taxable income to the company (since the rabbi trust is a grantor trust for income tax purposes) while the trustee keeps the entire policy proceeds. The threat of this potential tax liability and no correspond­ing assets should increase the likelihood that the company will pay the non-qualified benefits. However, if the company refuses to pay, substantial COLI cash values in the rabbi trust provide benefit security

Secular Trust
Asecular trust provides non-qualified plan participants with maximum security for their benefits. In addition to protecting executives against management change of heart and company change of control, a secular trust protects against company insolvency. When a company establishes a secular trust it irrevocably transfers the assets out of reach of corporate management and corporate creditors. Because the funds are no longer considered company assets the corporation can take a tax deduction at the time the trust is established. The participant must then pay tax on the assets set aside in trust on his or her behalf.

Using COLI instead of company assets to fund a secular trust offers tax advantages. Growth within the policies is not taxed and the executive's beneficiaries receive the death benefit tax-free.