A client from Brooklyn came to our office with an objective I hear often: setting up a trust for his grandchildren. He planned to contribute annually for their education but wanted a structure that was both tax-efficient and protected from creditors. He knew about annual gifting but was unsure how it worked with a trust. Our conversation turned to a specific, and often misunderstood, provision: the “5 or 5 power.”
This is a corner of trust law where a simple percentage point can make a significant difference in the stewardship of a family’s legacy. It’s also a concept frequently confused with entirely separate regulations.
What the 5 or 5 Power Is—and What It Is Not
First, a clarification. The 5 or 5 power has nothing to do with the five-year look-back period for Medicaid eligibility. That is a completely different area of law concerning long-term care planning. The 5 or 5 power is a specific tool used in gift and estate tax planning, rooted in the Internal Revenue Code.
The rule, found in IRC § 2514(e), creates a safe harbor for trust beneficiaries. Many trusts, particularly Irrevocable Life Insurance Trusts (ILITs), are funded with annual gifts from the person who created the trust—the grantor. For these gifts to qualify for the annual gift tax exclusion, the beneficiary must have a “present interest” in the funds. This is achieved by giving the beneficiary a temporary right to withdraw the contribution, often for 30 or 60 days. This is known as a “Crummey power,” named after the court case that established it.
When the beneficiary—as is almost always the intention—does not exercise this right and lets it lapse, the IRS could consider it a taxable gift from the beneficiary back to the trust. The 5 or 5 rule prevents this. It states that the lapse of a withdrawal right is not considered a taxable gift as long as the value of the property the beneficiary could have withdrawn does not exceed the greater of $5,000 or 5% of the total trust assets.
How This Power Functions in a New York Trust
Imagine a grandparent in Manhattan establishes a trust for a single grandchild with an initial funding of $200,000. Each year, the grandparent contributes another $18,000 (the annual gift tax exclusion for 2024) to the trust to pay the premiums on a life insurance policy.
Upon that contribution, the grandchild receives a notice of their right to withdraw that $18,000 within the next 30 days. The grandchild, understanding the trust’s long-term purpose, does not withdraw the funds. The 30-day window closes, and the right “lapses.”
Here is where the 5 or 5 power comes into play. The amount that lapsed was $18,000. We must compare this to the two thresholds:
- $5,000
- 5% of the trust assets (5% of $218,000 is $10,900)
The greater of these two is $10,900. Since the lapsed amount of $18,000 is more than $10,900, the excess ($7,100) is considered a gift from the grandchild to the trust. This can create future estate tax complications for the grandchild and requires careful drafting to manage. A skilled trust attorney anticipates this and builds in provisions to handle the excess, often using what are called “hanging powers.”
This federal tax rule is given its legal effect within the framework of a New York trust. While the power itself is a creature of the tax code, its release is governed by state law. New York’s Estates, Powers and Trusts Law (EPTL) § 10-7.2 addresses the release of a power of appointment, which is what happens when a beneficiary allows their withdrawal right to expire. The trust document must be drafted with both federal and state statutes in mind to function as intended.
Stewardship Through Intentional Design
Why go through this complexity? Because it allows for deliberate, generational planning. The 5 or 5 power is a mechanism that enables a grantor to make substantial, tax-free gifts to a trust, allowing its assets to grow for future generations without being eroded by immediate gift taxes. It facilitates the orderly transfer of wealth while keeping the assets under the prudent management of a trustee.
This isn’t about finding loopholes. It is about using established rules to build a durable structure for your family’s future. It turns a simple financial gift into a component of a much larger legacy—one that can fund education, support a new business, or provide a safety net for decades to come. The trustee, acting as a fiduciary, is bound to manage these assets for the long-term benefit of the beneficiaries, ensuring the grantor’s original intent is honored.
When I work with families, my focus is on these outcomes. The legal mechanics, like the 5 or 5 power, are the tools we use to build the structure. The ultimate goal is the preservation and growth of what you’ve built, for the people you care about most.
If you have an existing irrevocable trust, or are considering creating one, its withdrawal provisions must be correctly structured. We can perform a review of your current trust documents to analyze how these powers are defined and whether they align with your long-term family objectives.
