A client came to our office not long ago with a common and admirable goal. He wanted to set up a trust for his two grandchildren, seeding it now and making annual contributions. His intention was clear: to give them a significant head start in life. But his concern was just as clear—he didn’t want an eighteen-year-old to suddenly have unfettered access to a large sum of money. He wanted to give a gift, but he also wanted to instill a sense of stewardship. This is a frequent conversation in my practice, and it often leads to a discussion about a specific, and frequently misunderstood, tool: the “5 by 5 power.”
What the ‘5 by 5 Power’ Actually Is
The 5 by 5 power is frequently misunderstood. Many believe it grants broad authority to the trustee. This is incorrect. The 5 by 5 power is a right granted to the beneficiary of the trust. It gives the beneficiary the non-cumulative right to withdraw a certain amount from the trust principal each year.
The name comes directly from the limits placed on this withdrawal right. The beneficiary can withdraw the greater of:
- $5,000, or
- 5% of the total value of the trust principal.
The term “non-cumulative” is critical. If a beneficiary chooses not to exercise this right in a given year, it does not roll over. The opportunity for that year is gone. This feature prevents a beneficiary from ignoring the right for a decade and then suddenly demanding a massive lump-sum withdrawal. It provides limited, predictable access without undermining the long-term structure of the trust.
A Tool for Intentional Gifting and Legacy Stewardship
Why would a grantor include such a provision? The primary reasons are rooted in tax planning and the desire to balance generosity with prudence. The 5 by 5 power is a cornerstone of what are often called Crummey trusts, designed to take advantage of the annual gift tax exclusion.
For a gift to qualify for the annual exclusion, it must be a gift of a “present interest,” meaning the recipient must have an immediate right to use and enjoy the property. A gift into a typical trust—where assets are locked up for the future—is a gift of a “future interest” and doesn’t qualify. The 5 by 5 power solves this. By giving the beneficiary the immediate, unrestricted right to withdraw the contribution, it transforms the gift into one of present interest.
This has significant tax implications. It allows a grantor, like my client, to make substantial annual gifts to the trust for his grandchildren without filing a gift tax return or using his lifetime gift tax exemption. It is an efficient way to transfer wealth across generations.
Furthermore, the specific limits—$5,000 or 5%—are not arbitrary. They come directly from the Internal Revenue Code, specifically IRC § 2041(b)(2) and § 2514(e). These sections ensure that if the power lapses (goes unexercised by the beneficiary), it is not considered a taxable gift from the beneficiary back to the trust. More importantly, it prevents the entire trust value from being included in the beneficiary’s taxable estate should they pass away. It is a carefully calibrated exception that allows for flexibility without creating unintended tax burdens.
Drafting and Administering the Power in New York
While the tax framework for the 5 by 5 power is federal, its implementation happens within a trust document governed by state law. In New York, the trust must be drafted with precision. The language creating the power must be unambiguous, and the trustee’s duties must be clearly defined.
One of those duties is paramount: the trustee has a fiduciary responsibility to formally notify the beneficiary in writing every time a contribution is made to the trust. This “Crummey letter” informs the beneficiary of their right to withdraw the funds and the window of time they have to do so, typically 30 or 60 days. This is not a mere formality. It is the evidence that a present interest was, in fact, created.
The trustee’s broader responsibilities, including the duty to manage trust assets under the Prudent Investor Act found in New York’s EPTL § 11-2.3, are a matter of state law. A provision like the 5 by 5 power adds a specific, recurring administrative task to their plate, one that must be handled diligently to preserve the trust’s intended tax benefits.
For families in Brooklyn, Manhattan, and across the state, this tool allows for the intentional transfer of a legacy. It reflects a deep understanding of family dynamics—a desire to provide for the next generation without inadvertently discouraging their own hard work and financial discipline. It is an instrument of empowerment, constrained by wisdom.
Stewardship.
The 5 by 5 power is not right for every trust or every family. It is a specific tool for a specific set of goals. But for those who wish to gift methodically and tax-efficiently while protecting the core of their legacy, it remains one of the most effective provisions we can draft into a trust.
If you are considering how to structure a trust for your children or grandchildren, a productive next step is to outline the financial support you envision and the values you hope to impart. With that outline, we can sit down and design a trust structure that truly reflects your intentions.
