What Is the 5 by 5 Rule in a Trust?
Many beneficiaries assume that the trustee has total control over trust distributions. They believe that whenever they need money, they must ask the trustee, explain why they need it, and hope the trustee approves the request.
That is often true, but not always.
Some trusts include a provision known as the 5 by 5 rule, which may give a beneficiary the right to withdraw a certain amount from the trust every year without relying on the trustee’s discretion.
How Does the 5 by 5 Rule Work?
The 5 by 5 rule allows a qualifying beneficiary to withdraw the greater of:
$5,000
5% of the trust’s value
This right commonly applies to a surviving spouse, although a trust may grant it to another beneficiary.
Unlike a discretionary distribution, the withdrawal is not based on whether the trustee believes the request is reasonable. It is also not limited to health, education, maintenance, or support. When the trust includes the provision and the beneficiary qualifies, the withdrawal right is built into the trust.
For example, if a trust is worth $400,000, 5% would equal $20,000. Because $20,000 is greater than $5,000, the beneficiary could withdraw up to $20,000 that year.
If the trust is worth $60,000, 5% would equal $3,000. In that situation, the beneficiary could withdraw up to $5,000 because it is the greater amount.
Why Does the 5 by 5 Rule Exist?
The 5 by 5 rule comes from tax law. It creates a limited withdrawal right without giving the beneficiary so much control that the trust assets may be treated as belonging to that person for tax purposes.
In practical terms, the rule creates a safe zone. It gives the beneficiary some access to trust assets while limiting the possibility of larger tax consequences.
Is the 5 by 5 Rule Automatically Included in Every Trust?
No. The 5 by 5 rule only applies when it is written into the trust document.
Even when the provision appears in a trust, it may apply only to certain people, such as a surviving spouse or a specifically named beneficiary. It may also apply only to a particular subtrust created after someone dies.
The provision may not be clearly labeled as the “5 by 5 rule.” Determining whether it applies often requires carefully reviewing the trust’s actual language.
This can be especially important when a surviving spouse is dealing with both a survivor’s trust and a decedent’s trust. The surviving spouse may assume that the assets in the decedent’s trust are completely unavailable, even though the trust may provide an annual 5 by 5 withdrawal power.
Does the 5 by 5 Withdrawal Right Carry Over?
The 5 by 5 withdrawal right is typically annual and noncumulative.
That means an unused withdrawal usually does not carry over into future years. A beneficiary generally cannot skip distributions for three years and later request 15% of the trust.
For example, a beneficiary might have a 5 by 5 power for more than 15 years without realizing it. If the trust states that the power is not cumulative, the beneficiary cannot go back and collect all the amounts that could have been withdrawn during those earlier years.
The money remains in the trust and may eventually pass to other beneficiaries under the trust’s terms.
What Are the Possible Consequences of Taking a Distribution?
Having the right to withdraw money does not necessarily mean that taking the money is always the best decision.
Depending on how the trust is structured, a withdrawal could create:
Tax consequences
Long-term planning concerns
Unintended effects on the trust or its beneficiaries
A beneficiary should understand the provision and the surrounding trust terms before using the withdrawal power.
Check the Trust Before Assuming You Need Permission
The 5 by 5 rule can provide a clear path to a trust distribution when a beneficiary feels stuck, is nervous about asking for money, or is dealing with an overly controlling trustee.
However, the rule is not automatic, and unused annual withdrawal rights may be lost.
If you are a trustee, beneficiary, or surviving spouse, do not assume that the 5 by 5 rule applies or that it does not apply. Review the actual trust language and make sure you understand the provision before taking action.