February 7, 2023 •HoganTaylor
If your not-for-profit has an endowment, you probably know it’s a major responsibility. Endowment investments generally need to be managed by a financial expert, and your organization must adhere to certain regulations, particularly when it comes to spending. As a refresher — or primer for new employees or board members — here are the basics of endowment management.
Prudent decisions
First, it’s important to distinguish endowments from operating reserves. Endowments generally are designed to provide steady income to a nonprofit while its 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. For funds that aren’t restricted, organizations generally must conform to provisions of the Uniform Prudent Management of Institutional Funds Act (UPMIFA). Among other things, the UPMIFA allows nonprofits to include appreciation of invested funds as part of what is “spendable” in addition to realized gains, interest and dividends.
The act also provides guidance for “prudent” decisions, suggesting that spending more than 7% of an endowment in any one year generally isn’t fiscally responsible. And the UPMIFA makes it easier for nonprofits to identify new uses for older and smaller endowments that may be dedicated to obsolete or impractical purposes.
Spending income
Your spending policy will need to define how much of your endowment fund’s income can be spent on operations each year. Usually, 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.
Today’s difficult climate
The current high inflation, market volatility and recession worries make planning for your organization’s future challenging.
How HoganTaylor Can Help
The HoganTaylor Nonprofit team of business advisors and CPAs is comprised of former CFOs, controllers, and industry experts with extensive experience providing the guidance organizations need to lean forward again in their leadership. If you have any questions about this content, or if you would like more information about HoganTaylor’s Nonprofit practice, please contact Jack Murray, CPA, Nonprofit Practice Lead.
INFORMATIONAL PURPOSE ONLY. This content is for informational purposes only. This content does not constitute professional advice and should not be relied upon by you or any third party, including to operate or promote your business, secure financing or capital in any form, obtain any regulatory or governmental approvals, or otherwise be used in connection with procuring services or other benefits from any entity. Before making any decision or taking any action, you should consult with professional advisors.
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