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 management.
First, it’s important to distinguish endowments from operating reserves. Endowments generally are designed to provide steady income to a not-for-profit while its core investments grow untouched. That steady income can be a financial safeguard in times of crisis.
A significant portion of most not-for-profit 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 not-for-profits 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 not-for-profits to identify new uses for older and smaller ones that may be dedicated to obsolete or impractical purposes.
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. If you aren’t sure whether your spending policy has kept up with economic realities or developments within your organization, contact us for help.
To learn more about how PKF Texas serves not-for-profit organizations, visit www.PKFTexas.com/NotForProfit.