If you’d like to create a permanent pool of money that can be used to support the mission of a charitable organization long after you’ve passed on, an endowment fund may an option to consider.
Endowment funds are usually funded with irrevocable gifts of cash or securities. As a donor, you’ll receive the same charitable tax benefits you’d get by making a one-time donation. But instead of spending the assets all at once, the nonprofit invests them to grow over time and only withdraws a small portion each year to help pay for general expenses or specific programs.
Endowment versus endowment funds—what’s the difference?
Often, you’ll hear about multi-billion-dollar endowments at colleges and universities. In reality, these endowments represent the pooled value of all individual endowment funds established by individual and corporate donors.
While donors can specify how their own fund is used, they normally don’t have a say over how the money is invested or how much of their fund can be spent each year. These decisions, which cover all endowed assets, are made by the organization’s endowment investment committee, which is often comprised of senior staff members, key donors, board members and one or more investment professionals.
Most endowment funds are expected to last long after the donor passes on, which is why the investment committee strives to keep all of these funds growing in value over time, and limits the amount that can be spent from a fund on annual basis, typically between 4%-5% of its value.
Endowment funds generally fall into two categories: unrestricted and restricted funds.
Most nonprofit organizations prefer donors to establish unrestricted funds, which give them the greatest degree of freedom over how the gifted assets will be used. Unrestricted funds help pay for general operating expenses, such as salaries, building repairs and fundraising campaigns.
Most donors prefer to establish restricted funds, which are designed to support defined purposes. The donor works with the nonprofit to create a legal gift instrument that specifies exactly how the money in the fund should be used.
Many restricted funds are established by college alumni to support their alma mater. Most athletic and academic scholarships are paid for by restricted funds. Other funds finance permanent professorships in a specific department or help pay for annual conferences.
Donors also commonly establish restricted funds within community foundations, which are public charities that provide grants to local or regional nonprofit organizations. The donor can structure their fund to support one or more designated charities or specific areas of interest, such as environmental conservation, hunger relief, education or the arts.
Regardless of whether a donor establishes a restricted or unrestricted fund, the nonprofit organization should provide them with a least an annual report showing the fund’s value at the beginning and end of the year and a list of all withdrawals made from the fund.
The risks of endowment funds
With an endowment fund, you’re making a permanent commitment to a specific organization. If the organization changes its mission or acts in ways that conflict with your beliefs, you can’t get the money back.
And while restrictions can help ensure that the fund will only be used to carry out your wishes, these limitations can become problematic if the fund can no longer fulfill its intended purpose.
Donor restrictions became an issue in 2020, when the COVID-19 crisis compelled many cash-strapped colleges and universities to cancel or eliminate athletic programs, conferences and academic activities that were normally funded by restricted funds.
If the donors are no longer alive, and the funds can no longer be used as originally intended, they can end up in limbo, where they continue to grow but none of the money in the fund is used.
Can restrictions be lifted?
Donors who are still alive can alter the gift instrument to change the restrictions or remove them entirely.
If the donor is no longer alive, nonprofits may be able to petition their state’s attorney general or other state charitable regulators to request that these restrictions be removed. The nonprofit has to prove that the programs or purposes the fund was set up to support no longer exist. These laws governing the lifting of restrictions vary by state.
Other ways to give
While endowment funds enable you to provide ongoing support for charities for many years, there are other strategies you can use to achieve similar objectives.
- Annual gifts. You can schedule yearly donations to an organization to provide general support or fund specific programs or initiatives. If you’re able to itemize deductions, each donation may be tax-deductible and isn't subject to federal gift taxes. You can cancel your commitment at any time.
- Bequests. You can specify that a certain amount of money from your estate be donated to the charity after you’ve passed on. Many donors use bequests to establish restricted or unrestricted endowment funds.
Another option—donor-advised funds
If you like the idea of establishing a permanent charitable fund but want greater flexibility in choosing which organizations and programs to support, a donor-advised fund may be a more viable alternative.
A donor-advised fund is a public charity that offers the grantmaking benefits of a private foundation without the administrative burdens. While the most well-known donor-advised funds are established by investment companies and banks, most community foundations offer them as well.
You establish your own fund account with an irrevocable donation of cash or securities. The assets in your account may be managed by the fund’s authorized investment manager, or, in some cases, your investment adviser can manage the money. As a donor-advisor, you can request that grants be made from your account to support qualified public charities, either on a one-time or recurring basis. The fund’s administrator or Trustees must approve all requests.
You’re not required to give a certain amount each year. You can name anyone as a donor-advisor—your spouse, your children, your siblings--even your attorney or accountant. And you can also appoint successor advisors to take over after you’ve passed on.
Before you establish any kind of permanent charitable fund, it’s important to consider the tax and legacy planning implications before you make a decision. Your accountant or trust attorney can help you understand your options. You may also want to include your financial advisor in these discussions to help you figure out where these options fit into your overall financial plan.
This article was authored by Joelle Spear and Jeffrey Briskin. Joelle is a financial advisor and Partner located at Canby Financial Advisors, 161 Worcester Road, Framingham, MA 01701. She offers securities and advisory services as an Investment Adviser Representative of Commonwealth Financial Network®, Member FINRA/SIPC, a Registered Investment Adviser. She can be reached at 508.598.1082 or [email protected]. Jeffrey Briskin is Director of Marketing at Canby Financial Advisors.
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