What is 5 by 5 power?
The 5 by 5 power clause in the trust document gives the beneficiary the right to withdraw $5,000 or 5% of the fair market value of the trust account per year, whichever is greater. This is in addition to the regular income payment benefit of the trust.
The purpose of the clause is to guarantee the beneficiary minimum dollar distributions in the years in which the invested assets are to the detriment of the trust.
- A trust is set up in a will to provide regular annual income to one or more beneficiaries from estate assets.
- A 5 by 5 power clause in a trust allows beneficiaries to access an additional amount each year if needed.
- This amount exceeds $5,000 or 5% of the estate asset.
Understanding the 5 by 5 Power in a Trust
A trust is an alternative to a lump sum inheritance. Instead of wanting a large sum of money without any strings attached, a wealthy person can put the money in a trust. The money is then invested and the heirs are paid a predetermined amount annually, usually a percentage of the value of the trust.
Trusts may be designed to protect the interests of minor children, infirm heirs, or offspring who the beneficiary, rightly or wrongly, does not believe to be capable of intelligently handling a fortune.
A 5 by 5 clause can be included to give heirs access to an additional amount annually without giving the heirs the ability to reduce the value of the property. This is especially useful if the annual payment is reduced due to a decline in the investments held in the trust.
tie up money
It is not uncommon for wealthy individuals to tie strings with money left for their heirs. Ways in which high-net-worth individuals protect their money even after death:
- Spendthrift clauses protect money held in the trust from creditors chasing payments from the trust’s beneficiaries.
- The age specified in the trust delay payments is the minimum until the beneficiaries reach a certain age, typically 25.
- A clause may forbid the beneficiary from selling interest in the trust to raise cash.
- A “no contest” clause can deprive any beneficiary who challenges the terms of the trust.
Adam Harding, CFP®
Adam C. Harding, CFP® Investment and Financial Planning, Scottsdale, AZ
The primary reason individuals form trusts is to establish detailed instructions for the distribution of their assets when they have passed and cannot direct the assets themselves. Where a will may direct a lump-sum distribution of assets, the structure of a trust can provide continued guidance.
“5 by 5 power” is a way of providing certain parameters around a beneficiary’s access to funds in a trust. This basically means that each calendar year, they have access to $5,000 or 5% of the trust’s assets, whichever is greater.
So if the trust has $10,000, a beneficiary can withdraw $5,000, even though it is 50% of the trust corpus. Conversely, if the trust has $10 million, they can withdraw $500,000 under this arrangement.