E&F Advice & Administration
December 13, 2022
Spending and Distribution Policy Considerations for Endowments and Foundations
One of the most important governance items for a nonprofit board of directors or investment committee is a well-defined endowment spending policy. The policy plays a key role in managing and planning an endowed portfolio’s longevity and purchasing power, as well as contributions to the ongoing operating budget and/or grantmaking.
Volatile markets, changing behavior of donors and pressing funding priorities have led some nonprofit boards and investment committees to revisit their spending policies. Here we provide a brief overview of key spending and distribution policy considerations for both endowments and foundations, and touch on a few factors specific to each cohort.
Importance of a policy
A nonprofit uses its endowment to support the long-term stability of the organization’s mission. A foundation, on the other hand, seeks to carry out its philanthropic mission through grants. Regardless of the intent, to do so effectively, spending or distribution policies should:
- Create/maintain fiscal discipline and consistency.
- Promote a sound financial management process.
- Assist the board, investment committee or trustees in determining the investment program’s targeted rate of return and risk tolerance.
- Safeguard strategic alignment with the organization’s mission or goals.
The spending or distribution policy can impact the investment program’s ability to generate the funds necessary to support the endowment’s or foundation’s goals. Further, it can be an effective tool for budgeting and strategic planning. The spending or distribution policy should be defined in the investment policy statement, which in turn influences the long-term asset allocation and liquidity strategy, to strive for an investment return that can grow the purchasing power of the assets over the long term. (For more on this topic, please see Nonprofit and Foundation Investment Policy Statement Essentials.)
While spending policies are often an afterthought, they should be used as a critical governance input to help the investment committee, board or trustees determine the investment program’s desired rate of return and risk tolerance, including tolerance for investment losses. Spending policies should be transparent, outlining clear expectations for all stakeholders, and documentation should be comprehensive. These best practices apply to both endowments and foundations, although there are some nuances to each that should be noted.
- Most endowments are not subject to minimum spending requirements and can set their own spending policy, which can vary by jurisdiction. For example, some states consider a range of 2-7% annual spending to be prudent.
- A best practice is to start with a practical and conservative spending rate, resisting the temptation to start with a higher number and reduce over time. In cases where Glenmede sets the spending policy as trustee, 4% is a typical and reasonable spending rate. In most markets, a spending rate in excess of 5% can reduce the probability of achieving long-term growth in excess of spending and inflation.
- Often, organizations have multiple pools of funds that may be subject to varying spending policies. Specific donor gifts, which may have a specific spending policy, should be considered. While cumbersome, organized practices can help avoid confusion at the board level.
- The endowment’s board has discretion to create the spending rule, often at the direction of the finance or investment committee. Sometimes a range (3-5% as an example) can avoid the need to revisit or change annual spending practices, and it helps remove uncertainty for future staff, investment committee members or trustees to handle the endowed funds.
- Private nonoperating foundations must make qualifying distributions (grants and other charitable expenditures) each fiscal year of 5% of the average month-end market value of their noncharitable investment assets for that year (distributable amount). Any remaining distributable amount not paid out in the current fiscal year is considered undistributed.
- To eliminate undistributed income and avoid the risk of penalty, many foundations will pay their distributable amount in the current fiscal year through estimation in addition to their undistributed income from the prior year. If the foundation pays more than its distributable amount and the prior year undistributed income in the current fiscal year, the excess distributions may be carried forward for up to five years.
- Whether a foundation is acting in perpetuity or has plans to sunset will affect how it views portfolio construction and asset allocation.
- For example, if the foundation is sunsetting — also known as spending down or “spending itself out of existence” — the spending rate will be more variable. The resulting asset allocation is a glide path, with more dollars allocated to stable assets (fixed income and cash) as the foundation nears the end of its spend-down. Liquidity is paramount; investments in less liquid assets like private equity may not be suitable for a sunsetting foundation.
- On the other hand, a foundation acting in perpetuity can have a more unconstrained investment playbook, and can consider investing in less liquid assets like private equity or hedge funds.
- In recent years, and especially through strong markets in 2020-2021 alongside the pandemic, many foundations increased their distribution rate to a higher level (8%, 10% or even greater). Even for foundations intending to exist in perpetuity, it was recognized that paying out extraordinary market gains was prudent practice to cycle profits into communities in need. However, as markets and asset values have moved lower in 2022, some foundations are cutting funding or shifting to a sunsetting strategy. These extremes underscore the importance of balancing the need to give more with the need to exist in the long term, and thinking through the implications of volatile markets. Supplementing a foundation’s funding strategy by using Program Related Investments or Community Development Financial Institutions can be useful tools.
For more information on how your endowment or foundation can use spending or distribution policies, please contact your Relationship Manager or email Glenmede’s Endowment & Foundation Relationship Management Team at EFSolutions@glenmede.com.
 “Going for Broke: How Foundations Sunset, and the Reasons It’s Becoming Popular.” National Center for Family Philanthropy. https://www.ncfp.org/2019/02/13/going-for-broke-how-foundations-sunset-and-the-reasons-its-becoming-popular/. (accessed November 17, 2022)
This material provides information of possible interest to Glenmede Trust Company clients and friends and is not intended as investment, tax or legal advice. Any opinions, recommendations, expectations and/or projections expressed herein may change after the date of publication. Information obtained from third-party sources is assumed to be reliable but may not be independently verified, and the accuracy thereof is not guaranteed. No outcome, including performance or tax consequences, is guaranteed, due to various risks and uncertainties. Clients are encouraged to discuss any matter discussed herein with their tax advisor, attorney or Glenmede Relationship Manager.