The Five By Five Rule and What It Means for Trusts and Beneficiaries
The five-by-five rule pertains to certain withdrawal rights a beneficiary may have under the terms of a trust. It is an optional provision that may be added to a trust if the person creating the trust (the settlor) desires those benefitting from the trust (the beneficiaries) to have the ability to withdraw certain amounts from the trust.
What is a Trust?
A trust is a legal arrangement whereby a trustee (who may be the settlor or a third party) manages assets for the benefit of a beneficiary or beneficiaries (i.e., those who will receive distributions of the trust assets over time). A beneficiary can be an individual, groups or classes of individuals, or non-profit organizations (i.e., charities).
Trusts can be drafted to accomplish different goals and needs, and to address varying situations and circumstances. When properly drafted, a trust can be a flexible estate planning tool that allows you to decide how and when your assets will be distributed among your desired beneficiaries, while limiting overall tax liability.
What is the Five-by-Five Rule?
It goes by many names, including the five-and-five power, five-by-five power, or five-or-five power. It’s a provision in the trust that grants a beneficiary the annual power to withdraw the greater of $5,000 or 5% of the trust’s assets, while avoiding certain negative tax consequences (which are beyond the scope of this post) that might otherwise be applicable if the withdrawal right were exercised outside of those parameters. This withdrawal power is usually in addition to the other distribution provisions of the trust.
The settlor chooses the terms with regard to how and when a beneficiary will receive distributions of income or principal from a trust. These terms can include certain dates or ages, or they can include life events such as marriages or having children. Such terms can also include the five-by-five rule. The five-by-five withdrawal power is often granted when a settlor wants to distribute trust assets in smaller increments over time, rather than all at once. For example, a settlor may want to give a beneficiary some discretion to determine if or when the beneficiary wishes to access the assets of a trust, but the settlor may also concerned about turning over a large, lump sum of money to the beneficiary all at once.
What are the Benefits of the Five-by-Five Rule?
If a beneficiary is deemed to be to owner of a trust’s assets, certain undesired tax consequences may follow. The five-by-five power is one way a beneficiary can have some limited control over trust assets without being deemed the owner of such assets.
It can be used in trusts where the settlor and beneficiary are the same person, or in trusts where the settlor and the beneficiaries are different individuals.
What are the Disadvantages of Using the Five-by-Five Rule?
One potential disadvantage of the five-by-five rule is that the beneficiary may maximize his or her annual withdrawal right and receive the trust assets faster than the settlor would have liked.
Additionally, while trust assets typically cannot be used to satisfy debts owed by its beneficiaries, having a withdrawal right may provide debt collectors and creditors a mechanism to access trust assets to satisfy a beneficiary’s debts up to the annual withdrawal amount.
Contact an Estate Planning Lawyer to Create the Right Trust for You
LKP are highly experienced estate planning lawyers helping clients throughout Nevada. If you’re considering creating a trust, call us for a free consultation. Legal assistance is critical to ensure a trust is suitable for the objectives you wish to achieve.
We will discuss options that are available, then you can decide which of those options are best for you. Call us at 702-333-1711 or use our online contact form to speak to a Las Vegas, Nevada, estate planning attorney today.
Attorney Kennedy Lee practices in all aspects of trust and estate law. He views all legal issues from multiple angles (e.g. from litigation to administration point of view) to provide a higher quality of service to our client.
