What Do You Need to Know about 5 by 5 Power in Trusts?

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What Is the 5 by 5 Power and What Are the Benefits?

Some trusts have a 5 by 5 power included in them. You make this designation at the time that you create a trust and it provides some flexibility for your beneficiaries in how they can withdraw from the trust through the years.

Discover the benefits of 5 by 5 power for trust administration below as well as some of the potential disadvantages. Learn more about whether the 5 by 5 power may be the right choice for you and find out how an estate planning lawyer can help.

What Is a 5 by 5 Power?

The 5 by 5 power is an optional provision you can put into some trusts. It allows the beneficiary to withdraw $5,000 or 5% of the total value of the trust, whichever is greater. To understand how much this equates to, consider the hypothetical examples below:

  • Total assets of the trust equal $50,000. Since 5 percent of that total is $2,500, the beneficiary would be able to withdraw up to $5,000, because that is the greater amount.
  • Total assets of the trust equal $100,000. Since 5 percent of that total is $5,000, the beneficiary would be able to withdraw $5,000.
  • Total assets of the trust equal $200,000. Since 5 percent of that total is $10,000, the beneficiary could choose to withdraw up to that amount, since it is greater than $5,000.

The beneficiary does not have to make these withdrawals or max out their 5 by 5 power in any given year.

Benefits of the 5 by 5 Power

The purpose of the 5 by 5 power is to provide a beneficiary with options for withdrawing funds from a trust without being deemed to have what is called a general power of appointment over the trust. When beneficiaries have such access to trust funds that this general power of appointment is present, then the assets in the trust might be considered part of the beneficiary’s taxable estate. This can lead to an enormous tax burden for the beneficiary.

Another benefit of the 5 by 5 power is that it allows a beneficiary to withdraw some assets from the trust at a controlled level. Depending on the value of the assets in the trust, the limited 5 by 5 power can allow for years’ worth of withdrawals.

If a trust is administered by a particularly strict trustee, the 5 by 5 power also allows a beneficiary to access funds without meeting trustee approval requirements.

Disadvantages of the 5 by 5 Power

One of the biggest potential disadvantages of the 5 by 5 power is that it might inadvertently allow a beneficiary to run through trust assets much faster than you intend. Consider the hypothetical situation below:

  • A trust’s assets are valued at $20,000. For the sake of hypothetical math, assume that the assets don’t generate additional value through interest or income.
  • A 5 by 5 power exists.
  • Because 5 percent of the assets in the trust is less than $5,000, the beneficiary may be able to withdraw $5,000 each year.
  • The trust assets could be depleted within 4 years, which may not have been the intent of the grantor.

If the trust is larger, the beneficiary may quickly whittle it down by taking out 5 percent of the value every year. While you can set up a trust to help control how assets are withdrawn and used, if you have serious concerns about someone’s financial capability, you may want to consider options such as a conservatorship instead.

Another potential disadvantage of the 5 by 5 power is that it may open some of the assets of the trust up to creditors or others. If the beneficiary is able to make this withdrawal and does so for whatever reason, the assets may now be included when creditors take collections action, for example.

What Is the Crummey Rule?

Another way you might allow beneficiaries more flexible access to assets in a trust is via the Crummey rule. This is a trust arrangement that has to do with gifting and gift taxes. In short, beneficiaries are allowed to withdraw a certain amount from the trust as a “gift,” reducing the tax implications for both the grantor and the beneficiary.

However, the idea of the Crummey rule is that beneficiaries will see the benefit of allowing assets to remain in the trust longer. They can allow the right to withdraw this gift to lapse each year.

As with the 5 by 5 power, this has benefits and disadvantages. For example, if there are multiple beneficiaries for a trust, the lapse of one person’s gift withdrawal right is seen as a gift to the other beneficiaries. You can actually combine the 5 by 5 power and the Cummey rule to reduce some of the impacts of that issue, though.

Get Help With Complex Estate and Trust Planning

If you’re a little confused by all these concepts, it’s because they are complex legal and financial arrangements. There are many details to consider when you create a trust, and it’s important to understand your goals for the trust and communicate them clearly to an experienced estate planning or trust administration lawyer.

An experienced legal team can help you protect your assets, safeguard wealth for your loved ones, and make the right choices when it comes to details like the 5 by 5 rule. To get started on your own trust, contact Crow Estate Planning & Probate today by calling 931-213-7940.

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