5 by 5 Rule in Estate Planning

Many people wish to provide for their loved ones while ensuring trust assets last for years to come. Various estate planning tools can help protect their wealth, organize their financial affairs, and achieve their goals. The 5 by 5 rule is a provision some people use when creating a trust during the estate planning process.

The 5 by 5 rule, also called the 5 by 5 power in trust, provides beneficiaries with controlled access to trust funds while maintaining critical tax benefits. At Pennington Law, PLLC, we help Arizona residents understand and implement this helpful estate planning strategy when appropriate. Call or contact us online for a free consultation today.

How Does the 5 by 5 Rule Work?

The 5 by 5 rule allows trust beneficiaries to withdraw either $5,000 or 5 percent of the trust’s total value each year, whichever amount is greater. This arrangement creates flexibility while maintaining control over the trust assets. For example:

• Trust value of $80,000 – The beneficiary can withdraw up to $5,000 since five percent would only be $4,000.
• Trust value of $150,000 – The beneficiary can withdraw up to $7,500 (five percent of the total value).
• Trust value of $250,000 – The beneficiary can withdraw up to $12,500 (five percent of the total value).

Importantly, beneficiaries are not required to withdraw funds each year. The power to withdraw simply permits them to access a portion of the trust assets if needed. Any unused withdrawal rights expire at the end of each year and do not carry over to future years.

Does the 5 by 5 Power Offer Tax Advantages?

When structured properly, the 5 by 5 power provides significant tax benefits. This provision allows beneficiaries to access trust funds without triggering what tax law calls a general power of appointment over the entire trust. Without the 5 by 5 limitation, broader withdrawal rights could cause the full trust value to be included in the beneficiary’s taxable estate, potentially creating substantial tax liability.

When beneficiaries make withdrawals under the 5 by 5 rule in Arizona, those specific withdrawals become part of their taxable income. However, the remaining trust assets stay protected from estate taxes. This makes the 5 by 5 power an excellent tool for providing controlled access to funds while preserving the trust’s tax advantages. Our experienced Arizona estate planning attorneys can help you determine if including this provision aligns with your overall trust and estate planning goals.

Disadvantages of the 5 by 5 Rule

Despite its benefits, the 5 by 5 rule might not suit every situation. Small trusts could deplete quickly if beneficiaries consistently withdraw the maximum amount. For instance, a $60,000 trust could be reduced to zero in just 12 years through annual $5,000 withdrawals. Larger trusts might also face significant depletion if withdrawals outpace investment returns. Consider a $500,000 trust. Annual five-percent withdrawals of $25,000 combined with modest investment returns of three percent would steadily erode the principal over time.

Additionally, these funds lose the trust’s protection from creditors and lawsuits once withdrawn. Some beneficiaries might face pressure to make withdrawals they would otherwise avoid. This situation could force beneficiaries to choose between maintaining the trust’s protective benefits and accessing necessary funds.

The inflexible nature of the 5 by 5 rule can also pose problems. In years when beneficiaries face significant expenses, the withdrawal limit might prove insufficient. Conversely, in years with minimal needs, beneficiaries might still feel compelled to make withdrawals to avoid losing that year’s withdrawal right, potentially depleting the trust unnecessarily.

Impact of the 5 by 5 Rule on Trust Assets

The long-term effect of the 5 by 5 rule depends mainly on how the trust assets perform and how beneficiaries use their withdrawal rights. A well-managed trust generating strong returns might grow despite regular withdrawals. However, frequent withdrawals combined with poor investment performance could significantly reduce the trust’s value over time. At Pennington Law, PLLC, our financial professionals will develop strategies to help your trust maintain its value while serving its intended purpose.

How to Include the 5 by 5 Rule in Your Estate Plan

Adding a 5 by 5 provision requires careful consideration and proper legal documentation. We recommend working with experienced estate planning attorneys who understand Arizona estate tax and trust laws and can help you:

• Evaluate whether the 5 by 5 rule aligns with your goals
• Draft clear language defining withdrawal rights and procedures
• Include provisions for multiple beneficiaries if needed
• Structure the trust to maintain tax advantages
• Consider alternative distribution methods that might more effectively serve your needs

The 5 by 5 rule works best as part of a comprehensive estate plan tailored to your specific circumstances and objectives. Our attorneys will take the time to understand your unique situation before recommending any trust provisions.

Contact Pennington Law, PLLC for Trust and Estate Planning Assistance Today

Creating an effective estate plan requires balancing your current needs with long-term goals and tax protection. At Pennington Law, PLLC, we help clients throughout Surprise, Sun City West, Peoria, Goodyear, Buckeye, and surrounding areas develop estate plans that provide for their loved ones while protecting family wealth.

Our experienced attorneys understand the provisions of Arizona trust law and stay current with changing regulations that might affect your estate plan. We work closely with each client to create customized solutions that address their unique concerns and objectives.

To learn more about the 5 by 5 rule and its potential benefits, contact our law office today to schedule a consultation with an AZ estate planning lawyer.