Mom is 73 and has around 2.5 million in the trust. She pulls around 75k yearly from the trust and the trust owns her home, so that is another 15k year in prop./school taxes. She also receives my Dad's pension of around 1100.00 per month. The 100k would reduce the trust to 2.4 and her monthly dividend would need to be cut as well
If the trust buys an annuity with mom as the annuitant (but the trust is the owner), she won't be able to cash it in and take the hit (as she did last time). To produce $75K in annual income ($6250/mo, no inflation protection) for a 74 YO female, the trust would need to invest about $1 million. Take the rest of the money (1.5 million), invest it conservatively, and at the end of each year pay the taxes, insurance, and upkeep on the house and then give Mom an annual check based on her remaining life expectancy (straight from the IRS tables, no need for any subjective calls on you part, no need for her to come make a case to you, etc). She needs to know up front that the $6,250 per month will never change, it wont keep pace with inflation. The annual check to her will vary depending on investment returns, costs for the house, etc.
Or, even simpler, just just leave about $300K-$400K in the trust to pay for the housing repairs and expenses (taxes, etc) for the next few decades, and buy an CPI-adjusted annuity for Mom (as the annuitant, the trust would be the owner) with everything else. I don't know how much that would produce in monthly income, but it is what it is.
If you mom ends up in long-term care, that costs about $7,500/mo in most of the US, probably a lot higher in Long Island. An annuity and the pension you mentioned should cover $7,500. Maybe she'd need to be in a facility outside of LI to reduce costs. But using these streams of income to bound her expenses (living expenses now, aid to sis now, nursing home care later, etc) serves as an external source of discipline, a cap on these expenditures. That doesn't exist today--she sees $2.5 million, knows that she's 74 years old, and wants to spend the money while she can. Sis wants to help her.
There's no reason for you to be in the middle of this. It will generate ill will from Mom and sis, and as the cherry on top you'll also get blamed for crummy investment returns (even if just a dip) that happen if you are managing the trust's investments. They are both putting you in a bad spot by applying this pressure. Get a good insurer and consider your obligations to be met. As a side benefit, Sis will know immediately that there's no significant inheritance coming (other than the sale of the house). It has all been converted to a lifetime cash flow for your mom. This could be the wake-up call your sister needs to realize she's responsible for her future security. If she wants to squeeze mom for money, she'll need to get it all while Mom is alive, and do it month-by-month, because there's no big cash pile anymore.