What Is a 5 by 5 Power Clause in an Illinois Trust?

 Posted on January 30, 2025 in Estate Planning

While about 56 percent of Americans believe estate planning is important, only 33 percent of U.S. adults have documented their end-of-life plans in 2024 – a 6 percent decline from 2023. Most adults who do not have an estate plan cite "lack of assets" as the reason. In truth, virtually anyone from any walk of life can benefit from having an estate plan.

A trust has many benefits over wills, including no need for probate, protections against lawsuits, bankruptcies, and creditors, more control over how assets are distributed, tax benefits, and taking care of yourself during your own lifetime in the event of incapacitation. There are many different types of trusts for a variety of situations. Your Oakbrook Terrace, IL estate planning attorney can help you determine what your estate plan should include.  

What Is a Trust with a 5 by 5 Power Clause?

A 5 by 5 power clause in a trust gives the beneficiary of the trust the right to withdraw 5 percent or $5,000 – whichever is greater – of the fair market value of the trust each year. This is in addition to the trust’s regular income payout. The goal of this 5 x 5 power clause is to provide a regular yearly income to one or more beneficiaries of an estate, which can be written off as deductible.

A 5 by 5 power trust is an alternative to a lump sum inheritance. Rather than bequeathing a large amount of money to beneficiaries, the money can be placed in this type of trust. The money in the trust is invested, so it will continue to create income. If the investments held in the trust decline, then the annual payments can reflect that decline, and if they increase significantly, the same is true.

Most people who use a 5 x 5 power trust clause believe their heirs cannot handle a large sum of money wisely, so they choose to set up a trust that provides a yearly income. Beneficiaries of the 5 x 5 power trust are allowed by the IRS to reduce capital gains on the income, interest, and dividends generated by the trust’s taxable assets. Beneficiaries are not required to withdraw funds each year, but unused withdrawal rights do not carry over to the next year.

Are There Any Disadvantages to the 5 by 5 Power Clause?

The 5 by 5 power clause does not fit every situation. Small trusts can deplete quickly if multiple beneficiaries consistently withdraw the maximum amount. For example, with only one heir, a $60,000 trust would be reduced by zero in only 12 years.

Further, once the funds are withdrawn, they lose the protection from the trust from creditors and lawsuits. Certain situations could force beneficiaries of the trust to choose between accessing necessary funds and maintaining the protections of the trust. The success of such a trust is largely dependent on how well the trust assets perform and how beneficiaries use their withdrawal rights.

Other Ways a Trust Can Protect Assets Left to Beneficiaries

There are other ways a trust can be used to protect assets left to beneficiaries, including:

• A clause that forbids the beneficiary from selling interest in the trust to raise cash.
•  Spendthrift clauses can protect money left to heirs from creditors.
• Delayed payments based on age.
• No contest clauses that disinherit a beneficiary who challenges the trust terms.

Contact a DuPage County, IL Estate Planning Attorney

If you need more information regarding any aspect of an estate plan, including trusts, speaking to an experienced Oakbrook Terrace, IL estate planning attorney from Farooqi & Husain Law Office can be beneficial. Our attorneys are highly experienced in estate planning; Attorney Farooqi is one of the few Muslim attorneys who has a deep understanding of the intersection of Islamic personal law and U.S. law.