What is 5 times the power of 5?
The 5 x 5 power clause in the trust document gives the beneficiary the right to withdraw $5,000 per year or 5% of the fair market value of the trust account, whichever is greater. This is in addition to the regular income payment benefit of the trust.
This provision is designed to guarantee that beneficiaries receive minimum dollar distributions in years in which assets invested for the trust are reduced.
- A trust is created in a will to provide a fixed annual income to one or more beneficiaries of estate assets.
- A 5 x 5 power clause in a trust allows beneficiaries to receive an additional amount each year if needed.
- The amount is the greater of $5,000 or 5% of estate assets.
Understanding 5 by 5 Powers in Trusts
A trust is an alternative to a one-time inheritance. Rich people may put their money in a trust, rather than a large pool of funds willing to have no strings attached. The money is then invested and a predetermined amount is paid annually to the heirs, usually a percentage of the trust’s value.
A trust may be designed to protect the interests of minor children, infirm heirs, or descendants whose beneficiaries feel they cannot handle wealth wisely.
A 5 by 5 clause can be included to allow the heirs to receive an additional amount each year without enabling them to diminish the value of the estate. It is especially useful if the annual payment is short due to a decrease in investments held in the trust.
It’s not uncommon for rich people to attach strings to money they leave to their heirs. Even after death, ways HNWIs can protect their money include:
- The Spendthrift Clause protects funds held in the trust from creditors pursuing payments from the trust beneficiaries.
- The minimum age specified in the trust delays payments until the beneficiary reaches a certain age, usually 25.
- Terms may prohibit beneficiaries from selling trust interests to raise cash.
- A “non-compete” clause may disinherit any beneficiary who challenges the terms of the trust.
Adam Harding, CFP®
Adam C. Harding, CFP® Investment and Financial Planning, Scottsdale, AZ
The main reason individuals create trusts is to establish detailed instructions for the delivery of their assets after they have passed and cannot direct the assets themselves. Where a will can direct a one-time delivery of assets, the structure of the trust can provide ongoing guidance.
“5 x 5 power” is just a way to provide some parameters around the access rights of the beneficiaries to the trust funds. This basically means that in each calendar year, they can receive $5,000 or 5% of the trust assets, whichever is greater.
So if there is $10,000 in the trust, the beneficiary can withdraw $5,000, even though that is 50% of the trust corpus. Conversely, if the trust has $10 million, they can withdraw $500,000 under this arrangement.