What is a 5 by 5 Clause in a Revocable Living Trust?
Estate planning involves numerous strategies and tools to ensure that your assets are managed and distributed according to your wishes. One such tool is the 5 by 5 clause, often included in a revocable living trust. Understanding what a 5 by 5 clause is and how it works can help you make more informed decisions about your estate planning needs. Read on as we explain what this provision is and why you might want to include it in your trust. For help with wills, trusts, and other Washington estate planning documents, contact John Lutgens, Attorney at Law, to speak with a knowledgeable and experienced Vancouver estate planning lawyer.
What Is a Revocable Living Trust?
A revocable living trust is a legal document that places your assets into a trust during your lifetime. You maintain control over the trust and can make changes or revoke it as you see fit. Upon your death, the assets are distributed to your beneficiaries according to your instructions, bypassing the often lengthy and expensive probate process.
The Basics of the 5 by 5 Clause
A 5 by 5 clause, also known as a “5 or 5 power,” is a provision that allows the beneficiary of a trust to withdraw a portion of the trust principal each year. Specifically, the beneficiary can withdraw the greater of:
- 5% of the trust’s value, or
- $5,000
This annual withdrawal right is often used to provide beneficiaries with more flexibility and access to funds while still keeping the majority of the assets protected within the trust.
Why Include a 5 by 5 Clause?
There are several reasons why including a 5 by 5 clause in your revocable living trust might be beneficial:
1. Increased Flexibility for Beneficiaries
Beneficiaries can access a portion of the trust assets each year without needing the trustee’s approval. This can be particularly useful for unexpected expenses or financial needs.
2. Tax Advantages
A 5 by 5 clause can have favorable tax implications. Withdrawals made under this provision are generally not considered gifts, which helps avoid potential gift tax issues. Additionally, the remaining trust assets continue to benefit from estate tax protections.
3. Creditor Protection
Assets within a trust that includes a 5 by 5 clause are generally protected from creditors. Beneficiaries can access a limited amount of funds without jeopardizing the entire trust’s assets.
4. Ease of Administration
The 5 by 5 clause simplifies trust administration by providing clear guidelines on the amount beneficiaries can withdraw each year. This reduces the need for trustee intervention and potential disputes among beneficiaries.
How Does a 5 by 5 Clause Work?
Here’s a practical example to illustrate how a 5 by 5 clause works:
Imagine a revocable living trust with assets valued at $200,000. Under the 5 by 5 clause, the beneficiary has the right to withdraw the greater of $5,000 or 5% of the trust’s value. In this case, 5% of $200,000 is $10,000. Therefore, the beneficiary can withdraw up to $10,000 for that year.
If the trust’s value increases to $300,000 the following year, 5% would be $15,000. The beneficiary can now withdraw up to $15,000 that year.
Considerations and Limitations
While the 5 by 5 clause offers many advantages, it’s important to consider potential limitations:
1. Impact on Trust Assets. Regular withdrawals under the 5 by 5 clause can reduce the trust’s principal over time, potentially affecting the long-term goals and financial stability of the trust.
2. Beneficiary Discipline. The clause assumes that beneficiaries will withdraw funds responsibly. There’s a risk that beneficiaries might over-rely on these withdrawals, leading to financial issues if the trust’s assets diminish significantly.
3. Legal and Financial Advice. Incorporating a 5 by 5 clause requires careful planning and understanding of your estate planning goals. Consulting with an experienced estate planning attorney, like John Lutgens, can help you navigate these complexities and ensure that your trust is structured effectively.
Contact John Lutgens for Estate Planning Advice in Vancouver Tailored to Your Needs
A 5 by 5 clause in a revocable living trust is a powerful tool that offers beneficiaries increased flexibility, tax advantages, and creditor protection. However, it’s crucial to weigh the benefits against potential drawbacks and ensure that it aligns with your overall estate planning objectives. If you’re considering adding a 5 by 5 clause to your trust, or if you have any other estate planning questions, call attorney John Lutgens in Vancouver at 360-693-2119 for legal expertise and guidance tailored to your specific needs.