The Unique Benefits of an Endowment Fund

July 23, 2012

Endowments are important financial vehicles that not only perpetuate a not-for-profit’s good works, but also rank it in the eyes of other agencies, grantors and the business community.

Endowments can be attractive methods to create financial health and to reward major donors.

There are three types of endowment funds, and donors must be clear on what kind of endowment they are funding.

True endowment fund In a true endowment fund, the not-for-profit institution invests donated funds, and only the investment’s earnings are spent.

The gift itself is preserved “in perpetuity.” Often, not all of an endowment’s earnings are spent, and the excess is re-invested to grow the fund’s principal.

Term endowment fund This vehicle allows the principal to be spent after a period of time, or when some other predetermined event occurs.

A term endowment may be established to exist for, say, 25 years. Then, the principal may be spent.

Or perhaps a term endowment is established to fund the equalizing of employment rates for men and women in a certain profession. Once employment parity has been achieved, the principal is released.

Quasi-endowment fund So-named because the principal can be invaded upon a decision by the board, the “quasi-endowment” may not be an endowment at all, but rather a restricted gift.

Although the donor may intend the quasi-endowed funds to be invested in perpetuity, if the board decides the fund’s earnings underfund its purpose, the board can decide to use the principal to fund the purpose.

Endowments offer benefits to donors that other donation vehicles may not.

• Donations to endowments survive beyond the lives of their givers, creating true legacies. A donor who gives to an endowment is relieved of the burden of managing those funds.
• Through certain planned giving strategies, the donor may continue to receive income for life after making the gift.
• Endowment gifts can be made in annual increments in the event the donor does not want to give away all or too many assets at one time. The benefits of the gift for the donor may be enjoyed immediately.
• A donor who creates or gives to an existing endowment fund can be assured the organization will use the money for the purposes the donor wishes.
• Through perpetual investment, the benefit to the recipient is magnified beyond what the donor might have been able to give during his or her life.

Historically, endowments have earned as much as 10 percent and have paid out about 5 percent, or half of their earnings. The unpaid earnings are reinvested. Given a historical inflation rate of 3 percent, most endowments tend to grow in real dollar value.

In extreme circumstances, there is some risk that endowed funds held by true endowments and term endowments may be used for purposes not intended by the giver.

Endowment invasion is a practice that uses endowment funds for operating expenses and debt relief. The Uniform Prudent Management of Institutional Funds Act, adopted by virtually every state, provides guidelines for endowment invasion. Generally, endowment invasion is allowed only as a last-ditch method for avoiding the closing of the nonprofit because of financial woes.

Two books that offer insight into the benefits of endowments for donors: Money Well Spent by Paul Brest and Hal Harvey (Bloomberg), and Endowment Building by Diana S. Newman (AFP/Wiley Fund Development Series).

Donors who may be appropriate for endowment giving are often supported by their own financial and legal advisers. It is prudent for any not-for-profit organization to enlist the help of its own financial advisers when creating materials designed to elicit endowment donations.