DEFINITION of 5 by 5 Power in Trust
A “5 by 5 Power in Trust” is a common clause in many trusts that allows the trust’s beneficiary to make certain withdrawals. Specifically, a 5 by 5 Power (also called a 5 by 5 Clause) gives the beneficiary the ability to withdraw the greater of: a) $5,000 or b) 5% of the trust's fair market value (FMV) from the trust each year. (FMV is the price that property would sell for at present on the open market.)
BREAKING DOWN 5 by 5 Power in Trust
For the purposes of income tax, if the beneficiary doesn't exercise the 5 by 5 Power, over time the beneficiary could become the owner of the trust and be liable for taxes on the trust's capital gains, deductions and income.
A 5 by 5 Power allows for more flexibility if wealthy individuals are concerned with leaving large sums of money to potentially irresponsible beneficiaries. A 5 by 5 Power can set parameters on when a beneficiary can access funds. For example, a trust owner may establish the rule that a beneficiary can only access funds if he needs to pay for graduate school or other forms of continuing education and professional development.
Other categories of parameters include funding healthcare needs, first home purchases, and/or emergencies. Many trusts with 5 by 5 Powers will also allow the beneficiary access to the income that the trust investments produce (such as rental income from properties or bond interest) each year. A 5 by 5 Power can be added to a trust at any stage and can help guarantee a beneficiary a minimum dollar distribution.
5 by 5 Power in Trust and Additional Trust Features
In addition, the 5 by 5 Power trusts come in many forms and have a range of specific features that can be added or customized. One popular form is a personal trust that a person creates for him or herself as the beneficiary. These are separate legal entities from the trust creators and have the authority to buy, sell, hold and manage property for the trustor’s benefit. Personal trusts may be irrevocable or revocable. If irrevocable, changes cannot be made; if revocable, they may be made with the support of a trust and estate lawyer.
Legal advice is often necessary when setting up any form of a trust (personal or otherwise). Custodians can also help to hold and secure the assets, while investment advisors can help manage the trust assets until it is time for withdrawal.