Practical insight and analysis on the accounting, audit and tax issues impacting not-for-profit organizations.
How To Get The Most Out Of Your Nonprofit's Endowment Fund
Posted by admin Nov 21, 2017 4:00:49 PM
Many not-for-profit organizations rely on income from endowment funds to help meet operating expenses, ease cash-flow problems and supplement each year’s annual budget. Although endowments are often a financial bedrock for nonprofits, there are endowment fund rules that you must follow.Your endowment fund policy should take into consideration several factors that can affect the funds, including investment performance, inflation, operational changes, restriction of funds and — the only factor you truly can control — your nonprofit’s spending policy.
Understand Restrictions on your Endowment Fund
If endowment funds contain donor-imposed restrictions, your spending policy needs to defer to those in order for your organization to get the most out of the funds. But assuming funds aren’t restricted, nonprofits in every state except Pennsylvania must conform to provisions of the Uniform Prudent Management of Institutional Funds Act (UPMIFA), which replaced the predecessor endowment regulator, the Uniform Management of Institutional Funds Act (UMIFA), in 2006. Among other things, UPMIFA:
Allows nonprofits to include appreciation of invested funds as part of what is “spendable” in addition to realized gains, interest and dividends.
Provides guidance for “prudent” decisions, suggesting that spending more than 7% of an endowment in any one year isn’t prudent.
Makes it easier for nonprofits to identify new uses for older and smaller endowments that may be dedicated to obsolete or impractical purposes.
UPMIFA was generally seen as a welcome change to UMIFA because it lends itself to increased flexibility. However, because UPMIFA is complex, consult your financial advisor on how it affects your organization.
How Much of your Endowment Fund should you Spend?
Your spending policy should define how much of your endowment fund’s income can be spent on operations each year. Generally, this is defined as a percentage (between 4% and 7%) of a rolling average of endowment investments. A rolling average helps even out the ups and downs of market returns and prevents the endowment’s contribution to any one budget year from being significantly lower than contributions to other years.
However, this approach doesn’t address whether your endowment fund will be able to maintain a similar level of funding for future operations. Also, because investment returns usually don’t correspond to the inflation rates that affect your operating budget, your spending policy should be based on more than recent returns.
To factor inflation into your spending policy, you might 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.
Extend the Life of your Endowment Fund
A smart nonprofit endowment policy can allow your asset base to grow and, therefore, increase your fund’s chances of maintaining or growing real spending power for future years. Contact us for more information.
Bonus Tip: Market and advertise the benefits of giving in the form of endowment funds to potential donors. This article details the upsides for donors who either start endowment funds for nonprofits or give to existing ones.