(Based on a presentation to the 1995 Annual Meeting of the Canadian Association of Gift Planners)

What is an endowment?

An endowment is an investment fund set aside for the long-term support of an organization. Only the income, or a portion of the income, is expended. The principal is preserved intact.

How is an endowment different from a reserve fund?

The principal, as well as the income, from a reserve fund may be expended by the charity. For example, the reserve fund might be tapped for a building project or to cover a budget deficit. With an endowment, no invasion of principal is anticipated.

Should every institution have a reserve fund?

Yes. When revenues exceed expenses, the surplus should be set aside for years when the reverse may occur.

Should every institution establish an endowment?

No. An endowment is inappropriate for some charities. They may, for example, have been created to meet a short-term need or to assist victims of a disaster or refugees. Other charities require every available dollar to meet pressing social needs. Such charities should not establish endowments. Ordinarily, endowments are appropriate for such institutions as universities, hospital foundations, and museums.

What are the advantages of an endowment?

An endowment provides financial stability, makes long-range planning possible thanks to a predictable stream of income, and protects the institution in years when other revenue is reduced.

What are the disadvantages of an endowment?

An emphasis on contributing for the endowment may diminish the amount of funds available for current needs. Suppose, for example, that $1 million has been contributed for AIDS research. It may be preferable to spend the entire amount in the short term in pursuit of a cure than to invest the money in an endowment and have only $50,000 per year for research.

Sometimes building and preserving the endowment becomes an end in itself, and the purposes for which the money was given become secondary.

If an institution has an endowment, will it be more successful in attracting major gifts?

Probably not, for gifts from corporations and foundations, or if its mission is understood to be meeting pressing, immediate needs. Likely yes for gifts from individuals to a charity such as a university, hospital foundation, or museum. Major individual gifts to such institutions usually are directed for buildings, equipment, or endowments rather than current operations.

Should the institution accept endowment contributions subject to restrictions on the use of the income?

From the institution’s standpoint, the most desirable gifts are those with the fewest restrictions. Ideally, the institution’s board would have complete discretion as to how to expend the endowment income from year-to-year. However, the charity that does not permit donors to designate endowment contributions for specific purposes will attract fewer gifts for endowments. Therefore, the charity should accept endowment contributions subject to restrictions, provided those restrictions are consistent with the charity’s mission, are non-discriminatory, and include power-to-vary clauses.

Should the institution let donors establish endowed funds named for themselves and/or others?

A named fund is a way or memorializing and honoring a beloved family member or an admired individual. When the fund is named for the donor, it offers a kind of immortality by perpetuating that person’s name and values. Using capital accumulated during a lifetime to create an endowment to promote the causes in which one is interested gives life enduring significance. When these naming opportunities are provided, individuals are more likely to make large endowment gifts.

Should minimum amounts be required for individually-named endowments?

Yes. It is impractical to track numerous small funds. Also having minimums provides an incentive to make larger gifts in order to qualify for the naming opportunities. The minimum should probably not be less than $10,000, and higher minimums might be set for the various types of endowments. At a university, for example, the minimums might be:

• $10,000 – Unrestricted endowment
• $25,000 – Scholarship or Bursary
• $50,000 – Research fund
• $100,000 – Lectureship
• $200,000 – Fellowship
• $500,000 – Professorship ( Supplement to existing position
• $2,000,000 – Chair (New, fully-funded position)

 

Each institution must decide what categories and what minimums are appropriate for it, striking a balance between what the market will bear and the amounts required for the designated purposes. A gift of any size is acceptable when it will become part of the general endowment with no name identification. These minimums apply only to named funds.

How can an endowment be structured to accommodate and track individually-named endowments?

The endowment could be set up similar to a mutual fund with units assigned to each individually-named endowment. For example, the endowment begins with $100,000 cash, and the initial unit value is $10. Thus, 10,000 units are outstanding. Smith contributes $100,000 at the outset for the Smith Fund, and that fund is credited with 10,000 units. The assets are then invested in a portfolio of equities and fixed-income instruments, and the value fluctuates with market conditions.

Six months later, Jones contributes $100,000 for the Jones Fund. At that time the market value of the fund is $220,000, making each unit worth $11 ($220,000/20,000). the Jones Fund is credited with 9,090.91 units ($100,000/11).

The value of the units is determined at the beginning of each quarter, and contributions that come in during the quarter are added to the fund on the first day of the following quarter.

Distributions of earnings are also made on a quarterly basis. If, for example, the quarterly distribution is determined to be 20 cents, $2,000 (10,000 x .20) would be available for the purposes of the Smith Fund and $1,818.18 ($9,090.91 x .20) for the Jones Fund.

If the endowment were invested totally in cash equivalents with no fluctuation or growth in market value of each endowment, then unitization would be unnecessary. The distributions would be allocated according to percentage of the total fund constituted by each endowment.

Assuming that the endowment will be invested in securities with the objective of realizing some growth, unitization like a mutual fund is probably the simplest and fairest way to track the appreciation and income of each endowment.

Can the institution’s endowment include both individually-named funds for particular purposes and a general, undesignated fund?

Yes. All endowed funds, restricted and unrestricted, would be consolidated for investment purposes. All unrestricted gifts given to the endowment, or allocated to the endowment by the board, would go into the general fund, which would be assigned units just like the named fund. Each quarter distributions from units in the general fund would be expended at the discretion of the board.

How do the disbursement rules apply to endowments?

If a charity receives a gift or bequest subject to the donor’s direction that it be held in trust for at least ten years, the 80 percent disbursement rule will not apply (Section 149.1(e)(i) of the Income Tax Act). If the charity receives an unrestricted bequest and decides to invest the funds in its endowment, it will also not be subject to the 80 percent rule.

However, in either case it will be required to distribute for charitable purposes 4.5% of capital each year. Normally the capital will have been invested to generate this amount of income. The donor’s stipulation that the charity hold the gift principal for at least ten years should be stated in a letter or document signed by the donor.

How is building an endowment related to a planned giving programme?

Planned giving refers to the process of planning one’s contributions in order to meet both philanthropic objectives and family needs. Emphasis is placed on structuring the gift to maximize the tax and other financial benefits of the gift. While planned giving is often identified with deferred gifts such as bequests and charitable remainder trusts, it encompasses all forms of major gifts – current and deferred.

Conceivably, an institution could have a planned giving program without an endowment effort, or vice versa. However, experience has shown that many major planned gifts are designated for an endowment. Therefore, an ongoing planned giving programme would seem the best way to build an endowment.

What types of gifts can be made for an endowment?

Any of the following could be used to create an endowment:

• Outright gifts of cash or property
• Bequest
• Residual interest of a charitable remainder trust
• Residual interest when the donor retains use of a principal residence or other property
• Death proceeds or cash value of life insurance
• Gift element of a gift annuity
• Proceeds received at maturity of a stripped bond
• Retirement funds designated for the charity

 

What minimum gift amounts apply in the case of deferred gifts, the amount in effect at the time the gift is committed, or the amount in effect when the gift matures?

For example, a donor upon reading that the minimum for an endowed chair is $2 million, includes a bequest for that amount in her will and stipulates that it is to create an endowed chair in the name of her late husband. She dies ten years later, and the university receives the $2 million for the chair, but at that time the cost of a chair has increased to $3 million. Does the university still establish the chair in her name?

From a public relations standpoint, the best approach is probably to honor the minimum in effect at the time the donor made the commitment, but that may saddle the charity with finding extra funds from some other source since the endowment is insufficient for the intended purpose. Another approach, which better protects the institution, is to have the donor state in the will or other document that, if at the time the gift is distributed to the charity, the amount meets the then minimum requirements for a stated endowment, the endowment will be created, but if it is less than then minimum, it will be used for an alternate endowment bearing the donor’s name.

Instead of putting the eventual establishment of the endowment in doubt, the charity might specify one minimum for endowments funded with outright gifts, and another for endowments funded with deferred gifts. The anticipated inflation can be factored in the required minimum, and the donor is assured that the inflation-adjusted minimum is now committed.

How should endowment funds be invested?

Some boards, to guard against possible loss of fund value, take a very conservative approach and invest solely in very safe, fixed income investments, such as cash equivalents and government bonds. By failing to protect against inflation, this strategy may actually cause loss of the endowment’s purchasing power.

Other boards invest in a balanced portfolio with the objective of achieving some growth while also distributing a reasonable amount of current income. There will be fluctuations in market value, and in some years the endowment may actually decline in value. Yet the total return over time will likely be higher than if a more conservative philosophy had been followed.

Historically, equities have out-performed fixed income investments in total return. Thus, an endowment that contained equities in its portfolio would be worth more today than one invested solely in bonds and cash equivalents.

The financial objective for an endowed fund should be for total return, less expenses and distributions, to equal or exceed the Consumer Price Index (CPI) over a period of time. Of course, the investment mix must be such that sufficient income is generated to meet current needs of the institution and to satisfy the 4.5% distribution requirement.

Who should be responsible for investing endowed funds?

Normally this would be the responsibility of the Finance and Investment Committee, or other committee or agency to whom this responsibility is delegated by the board.

If the endowment is small, or the institution is just getting started with an endowment, the board may elect to invest all assets in safe, fixed income instruments until enough accumulates to make retention of a money manager practical. If the endowment is larger, the board will probably retain one or more money managers to invest the endowed funds. The managers will select the particular investments, but the board will probably provide some parameters regarding asset allocation.

For small charities one option worth consideration is to place the endowment in a designated fund within the local community foundation. That provides a diversification that would not be possible if the charity’s funds were invested alone.

What documents should be executed to establish endowments in various situations?

For a named endowment funded with an outright gift or irrevocable deferred gift, an endowment agreement, signed by both the donor and charity, is ideal. Such an agreement will:

• Preserve the memory of the donor.
• Clearly state the purpose and administration of the endowment.
• Serve as a pledge because the funding is specified.
• Provide for amendment, if necessary.
• Contain language satisfying the ten-year requirement.
• Help close the gift.

 

Though an endowment agreement is best, a letter signed by the donor and containing the necessary instructions would suffice. For a named endowment funded with a bequest, the bequest language is sufficient as long as it contains the essential information about name and terms. However, where the donor has advised the charity in advance of their intention to create a bequest by will, and the matter has been discussed, an endowment agreement is still very worthwhile. It can provide much more detail than the bequest language and may help to reinforce the commitment. Of course, the endowment won’t actually come into existence until the bequest is received.

An endowment agreement is also recommended when the endowment is to be funded with the death proceeds of a life insurance policy.

What reports should be made to endowment donors of named endowments?

On an annual basis send a report showing the amount in the endowment, the amount distributed from it during the past year, and how the distributions were used (not a detailed accounting but the general uses). Where individuals have been the recipients of the distributions (for example, a scholarship recipient), encourage them to write to the donor.

How should donors to endowments be recognized?

Their gifts should be recognized in the normal ways that gifts of that type and size are recognized: donor clubs for outright gifts, heritage club for deferred gifts etc. In addition, they may be recognized in any of the following ways as appropriate:

• Listing in special publication featuring endowment gifts.
• Listing in a special section of the annual report.
  (In both of the above, those who have set up named funds and those who have contributed to the general endowment could be differentiated).
• Announcements by the charity. (For example, “the John Smith Lecture.”
• Acknowledgments in scholarly and other publications. (For example, holder of endowed chair might note that funding was made possible by name of donor in published papers).

 

How can a charity attract gifts to the endowment fund?

Prepare and distribute a brochure discussing endowments and how to create them. Run articles about newly-established endowments in institutional publications. This plants the idea in readers and demonstrates that creating an endowment means something. Organize an awards ceremony to which donors are invited. One university allows the donors to hand scholarship recipients a certificate indicating the award. Publish profiles of donors who have created endowments. In planned giving literature, include examples about people who made a bequest, trust gift etc. to create an endowment. Above all, identify prospects for endowments, and have the appropriate person call on them and ask for such a gift.