By Doug Hasler, CPA, Director at Blue & Co.

In the first part of our series on establishing comprehensive endowment policies, we covered endowment creation and investment policy considerations. If you missed the first part of our series, you can read it here.

In the second half of our series on endowment management, we delve into the detailed strategies for effectively managing and spending endowment funds. We’ll explore how to craft effective spending policies and navigate the unique challenges of endowment management. By following these strategies, your organization can make the most of its endowments, ensuring they continue to support your mission for years to come.

Endowment Spending and Distribution Policies 

Generally, under SPMIFA, an organization considers the following factors in determining to spend or accumulate donor-restricted endowment funds:

• The duration and preservation of the fund.
• The purposes of the organization and the donor-restricted endowment fund.
• General economic conditions.
• The possible effect of inflation and deflation.
• The expected total return from income and the appreciation of investments.
• Other resources of the organization.
• The investment policies of the organization.

Spending policy for draws from the endowment for the donor-restricted purposes of the fund

• Establish spending rate – keep flexibility to adjust on an annual basis.
  • Some organizations have a policy that says the spending rate will be annually determined by the Board.
  • Some organizations have a policy that says the spending rate will be annually determined by the Board, with the rate not to exceed a specified percentage.
  • Even if not required to maintain the purchasing power of the endowment over time, most organizations want to spend prudently to allow the endowment’s purchasing power to have a chance to grow with inflation, so the value of the annual draw for programmatic purposes does not diminish in relative value over time.
• Date upon which draws will be calculated each year.
  • It is probably best to set a calculation date that is before the start of the year, and preferably before the budget for the year is established, so that the draw is already known when the budget is approved.
• What endowment fund balance or average fund balance will be utilized in calculating the draws?
  • It is very common to see a 12-quarter average of the endowment balances utilized, but some may use 16 or 20 quarters.
  • The 12-quarter average utilizes the 12 quarters ending before the date on which the draw is calculated.
  • Using a 12-quarter average provides smoothing through up and down market cycles.
  • Some use a three-year average, but it can be more volatile than the 12-quarter average due to the small number of touch points.
• Will draws begin to occur immediately upon establishment of the fund or at a later date (subject to the determination of the treatment of funds that have not yet reached the required funding threshold)?
  • If draws begin immediately, then there is more exposure to the fund moving underwater with spending combined with market volatility.
  • Some organizations wait for a period of one to three years before beginning draws to allow for some growth before spending starts.

Spending policy for administrative or management fees

• We often see fees charged to the fund at a rate of 0.5 percent to one percent per year to cover accounting, administration, and management.

Total spending policy – including the spending for restricted purposes of the fund and the draw for the administrative or management fees

• We believe organizations need to be very sensitive to the fact that the total spend from the endowment includes both the draws for spending on the restricted purposes of the fund and the draw for the administrative or management fee.
• The total of the two needs to be considered when determining the appropriate total spend from the endowment.
• Aggregating this total spend with the expected inflation rate provides the total return needed on the investment portfolio to allow the organization to maintain the purchasing power of its endowment.
• A balance of short- and long-term needs must be struck, and where that balance point lies at any one organization will be determined by its particular circumstances at any given time. This needs to be discussed in detail with your investment advisor.

Underwater endowment funds

• An endowment is underwater when the fair value of the endowment is less than the amount required to be maintained by donors or by law (most typically, this means that fair value is less than the historic value of the accumulated permanently restricted gifts to the endowment).
• Most interpret SPMIFA to permit spending from underwater endowments in accordance with the prudent measure required under the law.
• Even though spending is most often interpreted to be permitted from underwater endowments, some organizations take a conservative approach by policy (which can be another of those policies subject to change by the Board) not to spend from underwater endowments to give them time to recover.

Endowment Accounting and Reporting Policies

Endowment accounting policies

• Maintain adequate accounting for each individual endowment fund, including tracking of historic value or principal balance of the fund.
• Properly classify net assets with donor restrictions, including endowment funds, in the accounting records and financial statements of the organization.

Endowment reporting policies

• Prepare required disclosures about endowment details in the notes to the organization’s annual financial statements.
• Determine the appropriate level of reporting to management and those charged with governance.
• Report to donors – when the organization will report (regular intervals or upon request) and what the organization will report to donors.

As you can see, the development of comprehensive endowment policies involves consideration of a broad range of factors. Your Blue & Co. representative will be pleased to assist you in this process.