The 5 by 5 power (or 5 by 5 rule) is an optional trust provision that individuals can use in the estate planning process when creating their trust. This provision gives beneficiaries the option to withdraw money from a trust in a controlled way each year without completely draining the trust or disrupting its long-term goals.

It allows a beneficiary to withdraw the greater of:

• $5,000 or
• 5% of the total value of the trust

Typically, a beneficiary will determine which option yields the largest withdrawal amount. For example:

• If a trust is worth $90,000, 5% would be $4,500, so the beneficiary could instead take the $5,000 option.
• If a trust is worth $150,000, 5% would be $7,500, making this option better than the fixed $5,000 withdrawal.

It’s important to note that the beneficiaries are not required to withdraw from the trust each year but this provision provides flexibility to access funds, if needed, without special approval from the trustee.

Adding this provision to a trust can have a few benefits.

Keeps the Trust’s Structure and Goals Intact

The original intent of the trust is protected because withdrawals are controlled and limited to small amounts each year. This prevents beneficiaries from draining the trust too quickly while still giving them access to funds when needed.

Provides Beneficiaries with Financial Flexibility

Beneficiaries can take money if they need it, but aren’t required to withdraw anything. The trustee doesn’t have to approve these withdrawals and having a predictable, yearly source of income for the beneficiary can help with financial planning and stability.

Potential Tax Advantages

Trusts are often taxed at a higher tax rate than individuals and any withdrawal amount can be shifted to the taxable income of the beneficiary which could result in lower overall taxes.

However, there could be some disadvantages, depending on the goals of the trusts.

Trust Depletion Over Time

If a beneficiary takes the maximum withdrawal every year, the trust could shrink faster than the trust creator intended.

Creditor Exposure

Once a beneficiary withdraws money, it becomes part of their personal assets, which means creditors, lawsuits, or even divorce settlements could claim the money after it’s withdrawn.

Unintended Tax Consequences

Even if a beneficiary doesn’t take money out of the trust, the IRS may still treat them as having control over that portion of the trust. If they skip their withdrawal rights year after year, the IRS may start counting a larger portion of the trust as if it belongs to them for tax purposes. This could lead to unexpected taxes in the future-even if they never actually take any money.

The 5 by 5 Power can be included when drafting a trust or, in some cases, added later through an amendment (if the trust allows modifications.) Through this provision, some trust owners may decide to put the following types of parameters on trust withdrawals, only allowing beneficiaries to use the funds for purchases such as:

• Buying their first home
• Medical expenses
• College tuition or professional development.

Not every trust needs this provision, but it can be a useful tool for giving beneficiaries flexible but controlled access to money from the trust. If your settling up a trust or reviewing an existing one, an estate planning attorney can help you determine whether this provision can help you meet your overall goals.

Written by Matt Haupt

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