Donors and policymakers have become increasingly systemic in their consideration of nonprofit endowment management. Whereas the more traditional approach of donations lead to more tangible outcomes, like the addition of a new wing to a university or museum, many donors now aim to alleviate large-scale, complex issues, such as combating inequality and eradicating hunger.1 With this shift in giving comes a change in how nonprofits are spending their endowments.
Donors and policymakers are challenging the traditional approach of amassing a war chest of wealth and asking: How much should be spent now to solve today’s urgent problems and how much should be saved to deal with tomorrow’s concerns? This Nonprofit Advisor article explores both sides of the issue: i.e. spending your endowment like there’s no tomorrow or squirreling away for a “rainy day” fund, and focuses in on the shift in donor giving.
Reframing the Big Picture of Donations
Philanthropists like the Ford Foundation with a $12 billion endowment are now donating millions toward fighting inequality, where historically the majority of funds were allocated to already well-funded institutions.2 Drawing from the ageless ‘teach a man to fish’ adage, donors are trying to create social impact by reframing their approach. The best way to stay afloat is to evaluate how your nonprofit is managing their endowment and ask: Is your current endowment spending best practices optimal for reaching your program objectives? You may find that your grandparent’s approach to philanthropy isn’t as timeless as you think.
Save Today, Prepare for Tomorrow
The Tax Reform Act of 1969 marked the widespread acceptance that charities and private foundations should preserve their endowments to last indefinitely. In this reform, Congress maintained that nonprofits should have autonomy over their nonprofit endowment management. Similarly, private foundations were subject to rules that positioned foundations to operate in perpetuity—birthing the age of extensive university endowments and donor-advised funds.2
Many nonprofits preserve endowments to prepare for an economic downturn.4 According to the National Center of Charitable Statistics, by the end of 2005, nonprofit institutions had nearly $2.5 trillion in assets.2 When the 2008 economic crash occurred, nonprofits who had stockpiled wealth were prepared to weather the storm. This raises the issue of spreading the wealth among nonprofits that are less fortunate in collecting endowment funding to impact overall social change.4 As a result, many organizations meant to impact social change are looking to philanthropy as their source of funding.2
Today the wealthiest 0.1% of Americans own roughly the same amount of wealth as 90% of the population. Meanwhile, government funds are increasingly strained and nonprofit funds have grown. Under current tax law, private foundations that are exempt from federal income tax are subject to a 1% or 2% excise tax on net investment income. Universities and colleges are treated as public charities rather than private foundations and thus are not subject to the excise tax. In the House and Senate versions of the current “Tax Cuts and Jobs Act”, a provision exists whereby a 1.4% excise tax on net investment income will be applied to an educational institution.
Defining UPMIFA and its Impact on your Nonprofit
Uniform Prudent Management of Institutional Funds Act (UPMIFA) states nonprofits are allowed to spend from an "underwater" endowment. An endowment fund is “underwater” when its value is less than at the time of original funding— if the governing board determines it is prudent to do so based on a number of factors.
A key provision of UPMIFA states, “Subject to the intent of a donor expressed in the gift instrument an institution may appropriate for expenditure or accumulate so much of an endowment fund as the institution determines is prudent for the uses, benefits, purposes, and duration for which the endowment fund is established.”
Many states have adopted an optional provision to limit spending to 7% unless the board can show that the spending meets UPMIFA's standards of prudence. This board-approved spending policy must be based on the average market value of the endowment investments over the 12 quarters (or more) immediately preceding the calculation. This aspect of UPMIFA applies only to permanently restricted endowments, which are restricted by the donor or law. In addition, UPMIFA contains several standards of prudence regarding investing decisions and delegation of investment management.
Chipping Away at Large-Scale Issues with Real-Time Spending
Substantial work is involved on behalf of donors to launch nonprofit initiatives, especially since many philanthropists now want to see impactful social change. As such, benefactors want to be more heavily involved in the distribution process. In many instances, the days in which nonprofits could spend their endowments autonomously and without scrutiny is changing.
Many notable philanthropists have expressed concerns about perpetual foundations and have established clear endowment spending stipulations aimed at spending in real-time. Many have announced plans to spend all their assets in the lifetime of the donors.2
“There are certain dynamics that take over in terms of behavior, and one of those forces is usually the drive to perpetuate institutions,” said Warren E. Buffett, who is giving more than $30 billion to the Bill and Melinda Gates Foundation with the stipulation that it be spent promptly. “That dynamic — though undoubtedly subconscious — sometimes takes precedence over considering what might be best for society.”3
There is a growing acceptance that real change takes time, and as such the metrics to demonstrate the “success” of a nonprofit initiative with endowment money has been transformed. Philanthropists aren’t looking for the typical markers of success in a specific timeframe—they are often looking at more holistic metrics, for example, human sentiment, which create systemic change overtime. Being able to evaluate your endowment use and seeing how it aligns with your organizations overarching mission will help you determine whether you spend now, or save for later. But be mindful of the ways in which nonprofit funding is changing, and make sure you are in line with the times.
Finding the Right Path for your Nonprofit
As you can see from legislation, which has evolved over time, nonprofits have been given greater flexibility over endowment spending. Coupled with that flexibility have been significant changes in the accounting and disclosure over endowments in an organization’s financial statements. Reach out to your Friedman professional to discuss whether your organization’s accounting and disclosure over endowments are transparent and clearly presented.