What does a "5 by 5" power in a trust document mean?
It is not uncommon that wealthy individuals are concerned with leaving large sums of money to specific beneficiaries for the fear of those individuals acting irresponsibly with access to such a massive chunk of cash. To resolve this dilemma and to provide access to funds if income for a given year was low, trusts can include a "5 by 5 Power" to allow greater flexibility.
A majority of trusts are established to protect assets, and to provide for the ongoing well being of a specific loved one. In doing this, these trusts typically allow the beneficiary access to funds from the trust for an ascertainable standard relating to their health, education, support and maintenance. Many trusts will also allow the beneficiary access to the income that is produced from the trust investments each year.
In addition to this ascertainable standard and income payout benefit, the "5 by 5 Power" can be added, which allows access to the greater of: a) $5,000 per year, or b) 5% of the fair market value of the trust per year. This can help to guarantee an income beneficiary a minimum dollar distribution, regardless of the income generated from the trust. Be aware: should the beneficiary elect NOT to exercise their 5 by 5 Power over the year(s), adverse tax consequences could arise.
(Learn more about trusts by reading Pick The Perfect Trust.)
The question was answered by Steven Merkel.
This allows the beneficiary to withdraw the greater of 1.) $5,000 or 2.) 5% of the trust's value each year. Trusts can be tricky so you may want to consider getting some solid advice before doing anything that would jeopardize the covenants of the trust.
Hope this helps, Dan Stewart CFA®
The primary reason individuals create a trust is to establish detailed instructions for delivery of their assets after they've passed and can't direct the assets themselves. Where a will can instruct a one-time delivery of assets, the structure of a trust can provide ongoing guidance. The 5 or 5 power is simply a way to provide some parameters around the access a beneficiary has to the funds in a trust. It basically means that, in each calendar year, they have access to $5,000 or 5% of the trust assets, whichever is greater. So if the trust has $10,000 in it, they can pull out $5,000 even though this is 50% of the trust corpus. Conversely, if the trust has $10,000,000, they can withdraw $500,000 under this arrangement.
This is a great topic to discuss with your estate planning attorney and CFP. Of course, if I can provide any further insight, please feel free to reach out.
Adam C. Harding, CFP
I’ll try to be specific and general at the same time with this explanation. The most general explanation of the “5 or 5 power” is it gives the beneficiary of a trust the power to withdraw the greater of $5,000 or 5% of the trust assets in any given calendar year. Did the makers of the trust pull these numbers out of thin air? No, they did not. Those parameters were decided by IRS Tax code. This is important because, in general, beneficiaries normally don’t have these types of rights. The grantor of the trust makes the rules, the trustee enforces the trust, and the beneficiaries are recipients or “benefactors” of the trust. With a “5 or 5 power”, they actually get to decide something regarding the trust. Some (the IRS) would say this gives the beneficiary power. But too much power would be a bad thing for the beneficiary. If the beneficiary were to take more than the “5 x 5”, the beneficiary might be considered to have a “general power of appointment” over the trust, which could then have the assets included in the beneficiary’s estate.