Several words and concepts need to be understood before delving more deeply into building endowments.
An endowment is a broad term that is often used to describe the total of one or more endowed funds. An endowed fund is a charitable gift established in perpetuity in which the principal is invested for total return (both income and appreciation) and a small portion of the fund’s balance (usually four to six percent) is paid out, generally on an annual basis. The beginning principal is the value of the asset that was contributed by the donor; the income is the earnings produced by the principal; and appreciation (depreciation) is the gain (or loss) in the value of the principal since it was contributed. An organization may have several endowed funds, established by one or more donors and for one or more purposes, in its endowment.
Merriam-Webster’s Collegiate Dictionary, 10th Edition, states that to endow is “to furnish with an income for the continuing support or maintenance of an organization.” An endowment, then, is simply a pool of money that is invested to provide ongoing financial resources for the organization’s operations or for specific programs. Both state laws and accounting board standards apply to endowments.
Investment and spending rules for endowments
The Uniform Prudent Management of Institutional Funds Act (UPMIFA) governs endowment spending by charitable corporations and by some trusts. All states except for Pennsylvania have enacted some form of this law since it was approved in 2006. It is written with a minimum of legalese, and development and finance staff members should read it.
In Building Endowments Right from the Start, Lynda Moerschbaecher says: “In states where a state adopts the model or uniform law, each state has the right to select or reject provisions, to modify those provision or to adopt the law in whole. Therefore, every organization must check its own state law to learn the nonprofit corporate code or UPMIFA rules adopted by that particular state.”
Janne G. Gallagher, senior counsel for the Council on Foundations, says:
In the past, charity managers often believed that they could not rely on outside experts for investment advice and that investments had to be limited to the safest possible vehicles—cash, government bonds and, perhaps, a few blue chip stocks. UPMIFA not only freed charity managers to delegate investment decisions to outside managers, but also allowed them to invest assets for long-term growth, not just current yields. . . . Because UPMIFA lets charity managers invest for growth, not just income, UPMIFA also allows them to take that growth into account in making spending decisions for endowed funds.
The UPMIFA defines an endowment fund as “an institutional fund, or any part thereof, not wholly expendable on a current basis under the terms of the donor’s gift agreement.”
Types of Endowments
The Financial Accounting Standards Board (FASB) has identified three types of endowments:
1. True endowment (also called Permanent Endowment). The UPMIFA definition of endowment describes true endowment in most states. In these cases, the donor has stated that the gift is to be held permanently as an endowment, either for general purposes or for specific programs as identified in a written gift agreement. True endowment is restricted in a written agreement by the donor or is in response to a solicitation that promised to use the gift as an endowment. Under FASB, the portion of the permanent endowment that must be maintained permanently (not used up, expended, or otherwise exhausted) is classified as permanently restricted net assets.
2. Quasi-endowment (also known as Funds Functioning as Endowment—FFE). Reserve funds, financial windfalls, or unrestricted gifts that the board elects to put into endowment are quasi-endowments. Because a future board could vote to remove part or all of the quasi-endowment’s principal, it is not a true endowment. A board-designated endowment is classified as unrestricted net assets, and its principal may be spent under FASB guidelines. Thus, if the board established an endowed fund, it is quasi-endowment. If the donor makes a gift for an endowed fund, it is true endowment.
3. Term endowment. An endowment created for a set period of years or until a future event (such as the death of the donor) is known as a term endowment. After the term runs out or the event takes place, the principal may be expended. The portion of the term endowment that must be maintained for the specific term is classified by the FASB as temporarily restricted net assets.
The endowed funds in the organization’s endowment must be clearly labeled as one of these three types for accounting purposes. Each of these types may be used for designated or undesignated gifts—for general purposes or to benefit specific projects such as scholarships, professorships, camperships, staff positions, trainings, lecture series, and innovative programs.
An endowment program is an integral part of an organization’s comprehensive development program. It is a planned, consistent, and unending effort to build permanent endowment funds to support the work of the organization. Because endowments typically build slowly, primarily based on long-standing relationships between the donor and the organization and its leadership, endowment programs should be established by organizations that are committed to the growth of the endowment and comfortable with the long-term nature of endowment building.
The Role of Endowment in Planned Giving
Planned giving, or gift planning as it is sometimes called, is the preparation and design of charitable gifts to maximize benefits for both the donor and the organization. The Association of Fundraising Professionals defines planned giving as “the integration of sound personal, financial and estate planning concepts with the individual donor’s plan for lifetime and testamentary giving.” Paul Schervish, director of the Center on Wealth and Philanthropy at Boston College, defines a planned gift as “any gift that combines conscientious decisions about how much to give, to whom to give it, and when to give it. As such, virtually all giving, from all people, at all times is planned giving.” Planned giving is the process of choosing the most appropriate gift for the most important purpose in the most advantageous time frame for the donor, the charity, and the donor’s heirs.
Planned gifts, both current and deferred, can be completely unrestricted or directed to capital campaigns, specific projects, annual funds, or endowments. They are often given from accumulated assets, rather than current earnings. They are usually larger than operating fund gifts and completed infrequently, rather than annually.
Endowment building is different from planned giving. The endowment is what you do with the gift, rather than the planning for the gift or the gift itself. A true endowment gift is permanently invested, not spent for current operations or capital projects. It is held by the organization in perpetuity, with a portion of the endowment’s value used annually as the donor requested. Frank Minton, with Planned Giving Services in Seattle, Washington, states: “Most endowments have been built by planned gifts. Planned gifts and endowment gifts should therefore work in tandem.”