What is an endowment? And how do you determine when to spend from one?

• June 1, 2023
• Robert Zuengler

An endowment is an established fund of cash, securities, or other assets to provide income for the maintenance of a nonprofit entity. Typically, they have long-term goals, and in a lot of cases, are perpetual. Endowment donors may or may not impose certain restrictions or stipulations on the use of the assets of the fund.

There are three types of endowments:

1. Perpetual Endowment – Perpetual endowments are those that are meant to exist in perpetuity. The income will be used in accordance with explicit donor stipulations. It’s important to remember that the corpus (or original gift amount) is required to be maintained permanently.  
2. Term Endowment – Term endowments are those that will exist for a limited amount of time. For example, a donor gives $1 million and stipulates that the funds must be held for 40 years with the organization using only the income. When the term is up, the funds are released from restrictions and can then be used for your nonprofit’s mission, unless stated otherwise by the donor.
3. Quasi-Endowment – Quasi-endowments are board-designated funds with a spending policy attached. For quasi-endowments, it is important to remember that these are not donor-restricted funds. These funds are classified as without donor restrictions with a board designation.  

If your nonprofit is considering spending funds from an endowment, we suggest reviewing certain criteria before making that decision. The Uniform Prudent Management of Institutional Funds Act (UPMIFA) governs the management of funds for endowments. UPMIFA is law in 49 states and the District of Columbia, leaving Pennsylvania as the lone state where UPMIFA is not law. Every nonprofit should consider UPMIFA and the seven criteria it outlines for making investment management decisions:

1. Duration and preservation of the endowment fund
2. The purposes of the institution and the endowment fund
3. General economic conditions
4. Effect of inflation or deflation
5. The expected total return from income and the appreciation of investments
6. Other resources of the institution
7. The investment policy of the institution. These standards mirror the standards that apply to investment decision-making, thus unifying both investment and expenditure decisions more concretely

Because endowments typically come with stipulations, these criteria help guide the conversation on if and when your nonprofit might draw funds from them.

Many people ask: can you spend from an underwater endowment? An underwater endowment is when the current market value of the fund is less than the amount required to be maintained in donor restrictions. You can actually spend from underwater endowments. However, you should always consider the seven criteria above, and spending in that situation must be considered prudent. It is always recommended to maintain thorough and comprehensive documentation when making expenditures from underwater endowments.  

For more information on endowments, check out CLA’s recent endowment webinar.

This content was created by Brandon Tutty, CLA Nonprofit Manager.

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