Effectively Handling Endowment Gifts

by Dan Busby

Soliciting and accepting endowment gifts is a common practice by ministries. An endowment fund may be established when a restricted gift is permanently set aside by a ministry to fulfill a designated purpose. While the principal of the gift must generally be retained in the endowment fund and invested, the income from the principal is usually available for program purposes.

A giver may make an endowment gift to a ministry by imposing certain restrictions on the gift. Or, an endowment fund may be established by action of the board of directors and givers may be asked to contribute to the fund. Many ministries include an endowment component in fundraising campaigns.

There may also be “term endowments” that are not permanently restricted but restricted for a specified period of time. At the end of the time period, the principal is then released for unrestricted or purpose restricted use as set forth in the agreement.

All ministries should set aside cash reserves to protect against unexpected financial downturns. An endowment fund is an excellent way to do this. Endowments establish permanence for a ministry. Additionally, endowments benefit the charity because they provide a means for givers to continually upgrade their giving.

An endowment fund is typically not a separate legal entity. It is simply a component of the charity, best evidenced by a board resolution. Its tax-exempt status is that of the charity itself.

An endowment fund can be supportive of the entire range of programs of a ministry or supportive of just one aspect of the organization. A ministry can have multiple endowment funds.

It seems so simple to establish an endowment fund or accept an endowment gift, but this apparent simplicity belies many complex issues. Much of the confusion relates to terminology. The word endowment is often used too loosely and that may create problems. Plus, the qualifying terms that are used with the word endowment—pure, true, term, permanent and quasi—add to the complexity.

Types of endowments. An endowment fund of cash, securities, or other assets provides income for the maintenance of a ministry. This implies the principal of the fund is segregated from other types of gifts to ensure the identity and integrity of the funds.

It is possible for the assets of an endowment fund to be permanently restricted, temporarily restricted, or unrestricted in an accounting sense:

  • Permanently restricted. Endowment funds may be established by giver-restricted gifts and bequests to provide a permanent (also referred to as pure or true) endowment, which provides a permanent source of income. Giver restrictions on such endowments are often respected in the law. Ministry boards generally may not change the giver restrictions unless expressly granted such discretion in writing by the giver.

The portion of a permanent endowment that must be maintained permanently—not used up, expended, or otherwise exhausted, is classified as permanently-restricted net assets.

  • Temporarily restricted. An example of a temporarily restricted endowment fund is a term endowment, established to provide income for a specified period. For example, a giver might restrict the principal of the gift for ten years or until a certain event has occurred. Then, the giver might instruct that the principal may be reclassified as unrestricted net assets.
  • Unrestricted. A ministry’s governing board may designate a portion of its unrestricted net assets as a board-designated endowment (sometimes referred to as funds functioning as endowment or quasi-endowment funds) to be invested to provide income for a long but unspecified period. A board-designated endowment, which results from an internal designation, is not giver-restricted and is classified as unrestricted net assets. Generally, the governing board has the right to decide at any time to expend the principal of such funds.

Determining giver intent. Donor intent is often evidenced in one of the following ways:

  • If a giver desires that the principal of a gift is to be maintained inviolate and in perpetuity, and only the income from the investment of the assets be expended, the giver may stipulate these desires in the donative instrument.
  • The fundraising communication between the ministry and giver is often indicative of the nature of the gift. For example, if the ministry establishes an endowment fund and a giver makes a gift in response to promotional material about the fund, a permanently restricted gift has been made.

Board authority over endowments. The ministry’s board has authority in the following areas:

  • To establish endowment policies that do not violate federal, state or local laws.
  • Generally has the power to place unrestricted donations in a board designated (unrestricted) account.
  • May have the power to allocate a portion of a temporarily or permanently restricted gift (representing allocable planned giving costs) for unrestricted purposes (including a board designated endowment fund).
  • Generally has the power to direct the income from endowments (see next item).

Income from the endowment fund. Generally, the earnings on an endowment fund itself is not restricted and can be used to carry out the ministry’s ongoing activities. However, some endowment gifts stipulate the uses to be made of the income—for example, for restricted purposes or programs.

Are endowment fund interest and dividends expendable? How about gains and losses? This depends on relevant law, but it may be overridden by agreement with the giver. It is often best for the gift agreement or solicitation to define what components of investment income are expendable for what purposes.

Some ministries use a defined spending rate. If all gains, losses and income are expendable, they only spend, say 5%. This means that the unspent earnings are held as temporarily restricted. However, in a down market, it may be necessary for the organization to reduce the spending rate or subsidize from unrestricted funds since they cannot invade the principal.

Establishing endowment policies. Before accepting endowment gifts, a ministry’s board should:

  • Define the specific objectives the endowment fund must achieve for the ministry
  • Decide whether or not to use a professional investment manager to manage the endowment fund
  • Adopt a policy regarding the use of the endowment principal

A ministry’s “endowment” policy should distinguish between quasi-endowment and endowment types of gifts. This clarification is very important for proper giver communications and to insure that the proper accounting treatment is followed for these gifts.

Does an endowment policy established by a ministry have precedence over how givers generally understand the meaning of making an endowment gift? For example, a ministry’s policy states: “Donations to the endowment fund shall be considered unrestricted, unless given for a specific purpose or for a specific term by the giver, which restrictions shall be set forth in a giver agreement by and between the giver and the ministry.” If this policy is communicated to givers, the policy would have precedence. But if the policy is not communicated, the donations to the endowment are restricted, which is consistent with the generally accepted meaning of the term “endowment.”

Communicating with the giver. Communications to givers should be consistent with the ministry’s policies. If funds are solicited for quasi-endowment purposes, this should be clearly stated. If funds are solicited for endowment, these solicitations are for permanently restricted gifts.

What if fundraising campaign promotional material states that of the $25 million goal, $5 will be used for endowment? However, the intent of the ministry is to place the endowment gifts with their unrestricted net assets. Since the literature does not use “quasi-endowment” language, many givers would believe they are making permanently restricted gifts (based on the common definition of the word “endowment”) of which only the earnings may be used for operations.

If a ministry promotes a gift-giving opportunity as one that “endows” a specific project or program and the ministry plans to expend the gifts as they are received, it has misused the term endowment. It is possible that donors could compel the ministry to hold the funds as true or pure endowment. A contract or understanding and reliance by the giver may have inadvertently been created.

Summary. Endowment funds can be an important part of a ministry’s fundraising program. They require proactive planning by the organization’s board and clear understanding of the related legal and accounting issues, consistent communication with donors and the handling of the endowment funds with integrity and according to the wishes of the givers.

Common Endowment Problems

  1. Boards failing to understand that boards can designate unrestricted net assets but only givers can restrict net assets.
  2. Soliciting gifts for an “unrestricted” endowment fund. Gifts given to an endowment fund are restricted.
  3. Ministries taking the position that organizational policies supersede giver’s intent with respect to restricting endowment gifts.
  4. The use of the term endowment to raise funds when the ministry plans to use the gift principal for operating expenses.

 


This text is provided with the understanding that ECFA is not rendering legal, accounting, or other professional advice or service. Professional advice on specific issues should be sought from an accountant, lawyer, or other professional.

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