An endowment is a pool of funds donated or set aside to be preserved over time in order to support an organization’s mission. Nonprofits establish endowments for a variety of reasons, usually as part of their long-term strategic plan. Donors may contribute assets, such as cash and securities, and make pledges for future contributions to a nonprofit for creating an endowment.
While an endowment is a great idea for long-term planning and may provide continuous funding for charitable activities, it comes with some nuances that must be carefully navigated to ensure it is successfully managed and fulfills the intended purpose for the organization.
The main types of endowments are as follows:
Type |
Period |
Description |
Perpetual (donor restricted) |
Perpetuity |
Principal (corpus) preserved perpetually, while earnings may be expended based on donor stipulations. |
Term (donor restricted) |
Varies |
Principal preserved for a specified period or until the occurrence of an event, specified by the donor. |
Board designated |
Varies |
Principal usually retained, while earnings may be expended. Principal may be utilized upon board approval. |
“I received an endowed gift. Now what?” Nonprofits that never had an endowment may not know where to start. Endowments are governed by guiding documents, which may come in various forms such as a trust instrument, other written agreements from the donor or a board resolution. Identifying the right key words in these documents becomes crucial to ensuring that endowments are set up and accounted for correctly. Additionally, recognizing the type of endowment is also important to ensure the appropriate accounting guidance is applied.
Stipulations plus governing lawsEndowment operations are not only governed by the gift instruments but also by state law. Nonprofits may not appropriately prioritize these. The Uniform Prudent Management of Institutional Funds Act (UPMIFA) is a uniform act that provides guidance on investment decisions and endowment expenditures for nonprofit and charitable organizations. Except for Pennsylvania, all states and the District of Columbia have enacted their version of UPMIFA. Pennsylvania has its own endowment law not based on UPMIFA. Nonprofits may not realize that the donor’s stipulations take precedence over UPMIFA, albeit at times the donor stipulations are not explicit enough to override UPMIFA. This can create confusion.
Unclear donor intentIt is not uncommon for donor agreements to be vague when it comes to conveying the intent and purpose of the gift. These documents can be written by various persons who are not accountants, which can create challenges when determining the appropriate financial statement classification and operating mechanics of the endowment.
Managing endowmentsEndowment management can be complex and time consuming without proper resources and knowledge. Nonprofits need to track endowment activity in detail, and retain adequate supporting documentation for all gifts and any investment returns. Funds are often commingled in investment pools, which can create allocation challenges for nonprofit accounting teams. Various levels of expertise and strong internal controls are required for effective management.
Donor changesOver time, donors can submit modifications to their original gift instruments that are not correctly applied on a prospective basis. Nonprofits need to retain support from donors who make modifications to their endowment agreements as a record for any changes made to the accounting and treatment of an endowment from a donor.
Balancing the objectivesUnder UPMIFA, applying prudence to the fund to preserve value is the goal, not just retention of the dollar amount of the initial corpus. This is due to the time value of money. A gift of $100 in 1990 is not worth the same today; thus, to preserve the purchasing power of the fund’s principal, prudent investment and spending policies must be applied, while considering the donor’s stipulations for the fund’s use. Funds with deficiencies (where the fund value drops below the corpus) require special considerations related to spending and estimating future recovery. Many of these challenges also apply to a board-designated endowment fund. A board-designated endowment fund is created by a nonprofit organization’s governing board by designating a portion of its net assets without donor restrictions to be invested to provide income for a long but not necessarily specified period. Proper management and investment tracking are also applicable to this type of endowment fund. The board of the organization establishes the purposes for the endowment fund and this should be documented in the board minutes.
To effectively manage endowments, nonprofits need to be proactive, sophisticated and careful. They must be willing to make the required investment to educate their team and put the right processes and controls in place. Here are some tips to help organizations navigate the challenges discussed above:
Over the past three years, nonprofits have had to navigate some turbulent times with the disruption of the world’s economic and political environments due to the COVID-19 pandemic, inflation, and political unrest. Endowments and other reserves may be an opportunity for nonprofits to boost liquidity and permanently support their philanthropic goals and survive in an unstable economic climate. Nonprofits should weigh the benefits and costs of establishing and running an endowment. Organizations should also be mindful of the nuances described above and plan how to navigate these. With proper planning and the right resources, nonprofits can avoid improper classification of gifts and financial statement errors when it comes to accounting for endowments. Nonprofits can also lower reputational risk by ensuring compliance with applicable state law and donor stipulations.
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