Connections for Success



Make Endowment Funding Your Ally
Caitlin G. Gibbs

With demand for services up and donation support down, do you feel as if you are fighting a losing battle? Are you worried you cannot depend on the reserves you built to outlast a long economic downturn?

Do not be disheartened: You may have an ally in your endowment funds. Income from these funds may be able to help you meet operating expenses, ease cash-flow problems and even supplement next year’s annual budget.

Shape an Effective Policy

The success of your organization’s ability to make your endowment work for you will be affected by investment performance, inflation, operational changes and your endowment spending policy. Of these factors, you have the most control over the latter.

Know Your Restrictions

This discussion of endowment spending policies assumes your endowment funds are self-generated, meaning received without donor-imposed restrictions on how the income is used or the donor was silent on how investment income would be defined and determined. If your endowments do contain donor-imposed restrictions in these areas then your spending policy must defer to them.

Your spending policy also must conform to provisions of the Uniform Prudent Management of Institutional Funds Act of 2006 (UPMIFA), as enacted by your state. For example, the federal act:

  • Allows not-for-profit organizations to include appreciation of the invested funds, in addition to realized gains, interest and dividends, as part of what is “spendable”;
  • Eliminates the “historic dollar-value” rule requiring that any endowment restricted by its donors into perpetuity not fall below the amount of the original gift;
  • Outlines stronger guidance for the definition of “prudence,” suggesting that spending more than 7% of an endowment in any one year is not a prudent decision; and
  • Makes it easier for charities to identify new uses for older and smaller endowments that may be dedicated to obsolete or impractical purposes.

Because UPMIFA is complex and varies from state to state, you should consult your financial advisor on how it affects your organization.

Define Your Percentage of Investments

A spending policy should define how much of your endowment fund’s income can be spent on operations each year and is not required to define how that money can be spent.

Most not-for-profits define their spending policy as a percentage of the rolling average of the endowment investments over three to five years. This helps even out the ups and downs of investment returns and prevents the endowment’s contribution to any one budget year from being significantly lower than contributions to other years. This percentage often is set between 4% and 7%.

This approach may help smooth cash flow currently available to operations, but it does not address whether the endowment fund will be able to maintain a similar level of funding for future operations. Also, because investment returns usually do not correspond to the rates of inflation that affect your operating budget, your spending policy should be based on more than recent returns.

Factor in Inflation

To factor inflation into your spending policy, you may wish to start with a relatively conservative, inflation-free investment rate of return. Then adjust it for inflation to arrive at a spending rate you can apply on a year-by-year basis.

For example, if you determine that an inflation-free rate of return should be 3% and the inflation rate appropriate to your sector is 2.5%, your effective spending rate to apply to your asset base would be 5.5% for that year.

It is also important to keep a spending rate policy that is not directly linked to fluctuating investment rates of return. In other words, do not allow your withdrawals from endowment to go up just because investment growth on those funds has spiked up.

Make Your Policy Dynamic

The challenge is to develop a spending policy that is dynamic enough to take the above factors into account and not cause you to pull funds out of the endowment fund beyond what is budgeted and needed for operations. A good endowment spending policy will allow your asset base to grow, and therefore, increase your fund’s chances of maintaining or growing real spending power for future budget years.

For more information on endowment funding, please contact Caitlin Gibbs at [email protected] or call her at 312.670.7444.

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