Endowments–the Elephant in the Room

The following is a guest post by Lee T. Sullivan, CPA, CGMA, nonprofit team leader at Witt Mares, PLC.

Lee Sullivan

 While to one degree or another we have all been impacted by the economic doldrums of the past few years, nonprofit organizations in particular have been hit hard. As a result, many have turned their attention to the sustainability of the organization.

One favored method for ensuring continuity of the nonprofit’s mission is the establishment of permanent endowments. Endowments represent donor gifts which are required to be invested either in perpetuity or for a designated period of time. They also can occur from amounts designated by the nonprofit’s governing Board to provide income for maintaining the nonprofit organization.

While employing endowments can positively impact nonprofit longevity, management and the Board need to be aware of the Uniform Prudent Management of Institutional Funds Act (UPMIFA), created in 2006 and slowly adopted by most states to provide guidance regarding endowments, standards for endowment spending, and preservation of the original gifts in accordance with donor intent.

UPMIFA applies only to nonprofit charitable entities. It does not apply to trusts managed by non-charitable entities, such as corporations or trusts managed by individuals, which are governed by the 1994 Uniform Prudent Investor Act (UPIA). In addition, UPMIFA applies to all institutional funds, whether created before or after the enactment of the statute.

Building on the principles established by the previous guidelines (UMIFA), UPMIFA:

  • Provides consistent investment and spending standards to all forms of charitable funds, excluding trusts;
  • Strengthens the concept of prudent investing by creating more exact rules for investing prudently;
  • Abandons the use of historic dollar value (HDV) as a floor for spending and provides organizations with more flexibility in decision-making about whether to expend any portion of an endowment fund; and
  • Provides a process for the release or modification of restrictions on a gift instrument.

Eliminating HDV is particularly important because it enables a nonprofit to apply a spending rate that the governing board determines is prudent, even if application of that spending rate will cause the value of the endowment fund to fall beneath the value of the original gift.

It also helps to alleviate short-term barriers to spending in favor of a more long-term approach of preserving the endowment. Spending policies affect endowment duration and performance, and the ability to fulfill gift intent. UPMIFA contains guidelines for governing boards to consider in establishing safe harbors for spending and investing.

UPMIFA mandates that earnings be classified as donor restricted for legal purposes until they are appropriated for expenditure, unless otherwise instructed by the gift instrument. In addition, donor intent extends not just to the original gift, but also to earnings on the related investments.

Handling your endowments correctly involves examining your gift documentation carefully, analyzing the donor’s intent on each fund, and understanding current laws that apply to those funds in order to develop policies to preserve endowments. Bottom line: when establishing or planning for an endowment or quasi-endowment, management and the governing board must consider a number of factors.

Lee T. Sullivan, CPA, CGMA, is a Manager at Witt Mares, PLC and leads the firm’s Not-For-Profit team. Witt Mares, PLC is a regional accounting and consulting firm serving clients throughout the Mid-Atlantic. Please contact the author at lsullivan@wittmares.com or visit http://www.wittmares.com/.

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