If your nonprofit has an endowment, you understand that it’s a major responsibility. For example, organizations must adhere to certain regulations, including when it comes to spending from investment income. For this reason, many nonprofits opt to have a financial professional manage their endowment investments. But even if you have professional guidance, it’s important for both your staff and board members to know the basics of endowment management.
Making prudent decisions
First, it’s important to distinguish endowments from operating reserves. Endowments generally are designed to provide steady income while their core investments grow untouched. That steady income can be a financial safeguard in times of crisis.
A significant portion of most nonprofit endowment assets are restricted funds. Organizations generally must conform to provisions of the Uniform Prudent Management of Institutional Funds Act (UPMIFA). Among other things, UPMIFA allows nonprofits to include appreciation of invested funds as part of what’s “spendable” in addition to realized gains, interest and dividends.
UPMIFA also provides guidance for “prudent” decisions. It suggests that spending more than 7% of an endowment in any one year generally isn’t fiscally responsible; however, not all states have enacted this provision. And UPMIFA specifies procedures for nonprofits to change an endowment’s purpose — useful for those that may be dedicated to obsolete or impractical purposes.
Creating a spending policy
Your spending policy should define how much of your endowment fund’s income can be spent on operations each year. Often, this is defined as a percentage of 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 just 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 an annual basis.
Keeping it current
If you haven’t done so recently, now’s the time to review your organization’s endowment spending policy. Economic realities or developments within your nonprofit may have changed since your policy’s inception. Check with your CPA or investment professional to discuss changes to your policy to meet your needs.
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