Determining Endowment Spending, Savings and Gifting Rates

Managing an organization’s endowment fund is a significant responsibility. Large organizations with major portfolios have skilled professionals who understand and work in the financial markets each day. For many organizations with moderate investments, endowments, and limited professional staff, the management task can be daunting.

We strive to educate those individuals assigned with the difficult responsibility of managing the endowment, and determining spending rates, savings rates and gifting rates.

This document explains the various types of endowment funds, designed to assist in the endowment management process.

Types of Endowment Funds

There are three types of endowment funds generally held by colleges, universities, churches, health care organizations, and community foundations:

  • A True and Permanent Endowment
  • A Temporary Endowment
  • A Quasi Endowment

True and Permanent Endowment

A true and permanent endowment is created by a donor through gifts and bequests, the terms of which stipulate that the principal must remain inviolate and only the income or a total return formula for the distribution of interest, dividends and appreciation may be used for the purpose of the endowment. The use of income from these endowed funds may be restricted by the donor or determined by the Foundation Board of Directors. Unless the donor specifically states that any undistributed income and unused capital appreciation “must retain the same true and permanent endowment status” it will not contain the same restriction and the original gift.

Example: Mrs. Jones bequeaths $100,000 to her church. She states that the income from her gift is to be restricted and used to repair and/or replace the stained glass windows. In the ensuing twenty years the fund grows to $200,000. If Mrs. Jones did not state that any undistributed income and appreciation carry the same restriction, then the additional $100,000 does not retain the restriction and may be considered “unrestricted.”

Temporary Endowment

A temporary endowment, sometimes called “funds functioning as endowment,” is created by the organization from a donor(s) gift or bequest in which the donor does not specify its use. This often occurs when a campaign is launched and a donor makes a gift to be used later at the discretion of the organization. These funds are invested as if they were true and permanent endowment; however, unlike a true endowment, the institution may authorize the expenditure of part or the entire fund principal.

Example: Recently Mr. Jones contributed $500,000 to his college to be used for building renovations to Old Main. Since the construction date was more than one year away, the board placed the funds in a temporary account within the endowment. The fund would earn interest, dividends and be able to gain appreciation as a normal endowment account. When construction begins, the board would remove the funds for the intended purpose.

Quasi Endowment

A quasi endowment functions in the same manner as a true and permanent endowment except that it is created by the organization from institutional funds rather than from an individual donor. Therefore, it is the discretion of the organization’s board, in this case the, Foundation board, to expend any or the entire fund principal. The board may also elect to continue the existence of the quasi endowment fund.

Example: The Medical Center has experienced success from operations and has a excess of revenues over expense of $2 million. The Board of Directors decides to create a Quasi Endowment with the $2 million. They decide to call it a “rainy day fund.” Since the board created the fund, they also have the authority to terminate the fund.

Setting Policies

It is important when establishing an endowment to have a long term view. A nonprofit endowment is an invested fund designed to have systematic withdrawals to support the ongoing operations of the organization. The intent is to provide long term financial stability.

With this in mind, it is imperative that each organization develop and maintain certain policies for the financial well being of the fund and the organization. The following are three critical policies to consider:

  • Organization Endowment Spending Policy
  • Organization Endowment Savings Policy
  • Organization Endowment Gifting Policy

Organization Endowment Spending Policy

The spending policy of the organization managed endowment funds shall be as follows unless directed differently by donors or by board action:

We recommends using that no more than five (5%) of the three year trailing average market value held by the portfolio managers shall be returned to the organization for distribution as directed. This takes into account dividends, interest and appreciation of each fund. Should actual dividend and/or interest income equal 4% of the market value of the portfolio, the manager is directed to recover 1% of any principal appreciation to equal the 5% withdrawal.

Organization Endowment Savings Policy

While endowments need to know how much that are going to withdraw (spend) each year, they also need to know how much of the endowment income are they going to save each year. The savings rate is equally important as the spending rate. Savings rates are developed individually with each organization. A policy that directs one or two percent of the total return to be reinvested is a prudent approach.

Organization Endowment Gifting Policy

Often forgotten in the management of an endowment is the gifting rate. This rate literally means “how much does the organization need to raise” in order for the endowment to keep pace with the organization’s needs. If the organizational budget increases by 4%, how much more income will be needed from the endowment and therefore “what is the amount of new gifts to be required.”

While managing an organization’s endowment fund can be quite daunting, we believe a little education goes a long way. Coupled with the right advisor, individuals assigned with the difficult responsibility of managing the endowment, and determining spending rates, savings rates and gifting rates, can make the sound decisions to put their organizations on the path to long-term financial security and sustainability.