By: Elaine E. Bedel, CFP®
Have you ever been asked to make a charitable contribution to an endowment? There is often confusion with respect to giving to an endowment versus giving directly to a charitable organization. The one major difference is that when you make a gift to an endowment, you really are making “a gift that keeps on giving”.
Anytime you make the decision to share your hard-earned money with a charity, you want to make sure your personal intent is being maximized. If your goal is to have 100% of your money used immediately to meet the goals of the charitable organization, then giving to the “annual fund” or the “operating fund” of the charity is very appropriate. In most cases, your contribution will be used as needed or as you have specifically directed to carry out the mission of the organization. For example, you may make a contribution to an animal shelter which will use those dollars, generally within the year, to pay for food and housing for the animals and funding for the staff.
If on the other hand, you would like your money to make a long-term impact, you may want to consider a gift to the endowment fund of a charitable organization. Academic, cultural, and religious institutions as well as significant community funding organizations all tend to have endowments. The largest endowment in the United States belongs to Harvard University. As of June 30, 2009, its value was $26 billion. The Women’s Fund of Central Indiana and the Rotary Foundation of Indianapolis are examples of local community funding organizations with endowments.
How Does an Endowment Work?
When you make a contribution to an endowment fund, your money is not spent. Rather, it is invested. Each year thereafter, a specific percentage of the endowment fund is withdrawn by the charitable organization and used to meet its mission.
The intent of an endowment is to have its fund grow over time through appreciation and earnings of the investment portfolio. The annual distribution percentage is limited to an amount that is less than the anticipated total investment return of the portfolio in order to allow the endowment fund to increase in value. Generally, a five percent distribution is considered prudent.
As an example, if the investment portfolio of the endowment fund earns a return of 9% and the charity takes a 5% withdrawal, the endowment fund will still increase in value by 4%. Each year, as the endowment continues to grow, the 5% distribution amount will also increase.
Many organizations will require an endowment fund to have a minimum of $1,000,000 before any distributions will be made. A one million dollar endowment will generate $50,000 for the charity to spend at a 5% distribution or “spending” rate. As the fund grows and reaches ten million dollars, the 5% distribution will equal $500,000. In order for a charitable organization to have an annual distribution of $1,000,000 to use to achieve its mission, the endowment will need to grow to twenty million dollars.
The Gift that Keeps on Giving
Making a charitable gift to an endowment allows your money to continue to “make a difference” year after year. Since only a portion of the investment earnings and appreciation is spent each year, your gift remains intact into perpetuity.
Impact of Negative Market Returns
Just like your personal investment portfolio, when the markets are down, the endowment may suffer an investment loss instead of a gain. That happened in 2008. When an endowment fund goes down in value, the 5% distribution would also go down. In order to prevent a charity from having a drastic swing year-to-year in the annual distribution amount, an average of the endowment value over a period of years (usually three to five years) may be used to calculate the 5% withdrawal. Some organizations use a more complex formula to even out the annual distributions even more. When using an average or a formula to calculate the annual distribution, the impact of a negative market can be minimized.
Summary
A charitable contribution to an endowment fund allows your gift to “keep on giving” year after year. When considering your gift, you cannot make a wrong choice. Both the annual fund and the endowment are important for the long-term sustainability of any charitable organization.
