New York Estate Planning & Elder Law Blog
Every trust document is different; the terms of a trust can vary greatly, giving the beneficiaries either a broad range of power or can limit a beneficiary’s power to only include specific rights. Some of the differing terms of trust include: how the income and principal investments are able to be distributed, when, and under what circumstances, if the objective of the trust is either for growth or to maintain balance, when a beneficiary receives a distribution and under what circumstances, such as age attainment or education attainment, as well as whether the beneficiaries have a right of withdrawal also known as 5 by 5 clause.
What is a 5 by 5 Clause?
A 5 by 5 clause, or right of withdrawal, must be specifically stated in the governing trust. The right occurs once a year generally, and will allow the beneficiary to take up to 5% of the value of the trust out to be included in their current tax year or to take $5,000, whichever is greater at the time. If the trust contains a right of withdrawal, the trustee must notify the beneficiary within a reasonable time of their ability that year to withdrawal and the beneficiary must indicate their wish to exercise the right in part or in total or whether they chose to forego taking the amount. In order for the beneficiary to qualify the income under present interest, and therefore exempt under the gift exemption that year, they must have a vested economic interest to the income and principal of the trust.
Potential Tax Implications
Depending upon the relationships in the trust, there may be complications if a beneficiary decides to not take their right of withdrawal in the current year. If the remainderman is another individual, when the beneficiary gives up their current right of withdrawal, that interest is transferred to the remainderman, which may be taxable gift to the remainderman, depending upon the terms of the trust and the power of appointment rules. For tax purposes, the beneficiary will continue to be viewed as owning the property that they either took the right of withdrawal on or let lapse. Thus, whether a beneficiary decides to take the right of withdrawal, they are considered to have an interest in the trust property as the owner of that percentage.