Should Foundations’ Endowment Spending Increase to Address Pandemic, Racial Injustice?

Should Foundations’ Endowment Spending Increase to Address Pandemic, Racial Injustice?

The downpour of human needs that's surfaced in 2020 is challenging foundations to spend more of their asset bases.

Most private foundations derive all or some of their revenue from earnings on invested endowment funds. The rule of thumb for spending from an endowment centers on a rate somewhere in the 5 percent range.

To calculate spending rates, endowed assets are valued on a multiyear rolling average, often set at 12 quarters. This provides a “smoothing effect” so that annual spending is predictable and foundations can plan for the effects of market spikes and leaps.

The 5 percent spending rate is based on long-term investment return data, as a percentage that allows boards of directors to preserve endowment assets, account for inflation, and maintain the same buying power over multiple generations (“in perpetuity”).

The philosophy underpinning the 5 percent rate is that the needs of future generations are likely to be as great or greater than those of current generations. To preserve the potential to spend the same amount or more in the future, foundations must spend and invest prudently today.

Racial Justice rally at the Minnesota State CapitolAmid the Covid-19 pandemic, many nonprofit advocates are loudly recommending that the 5 percent rule be set aside, at least this year. They argue that a 100-year pandemic is by definition historic, and the impact on the nonprofit sector sufficiently dire, that a higher spending rate is urgently needed. Their perspective: If ever you were saving for a rainy day, the fierce storm has arrived.

Private foundations are subject to an excise tax, which is doubled if the philanthropy fails to pay out at least 5 percent of net assets in a given tax year on grants and related program spending. Calculating the 5 percent payout is complex, based on the spending that can be counted and which expenditures must be excluded, but suffice it to say there are significant incentives for adhering to the “at least 5 percent” rule.

Are nonprofit advocates right in suggesting it’s time for foundations to increase endowment payout? Consider a recent blog posting from FSG, one of the largest consulting firms to the nonprofit sector. “Five percent is the floor, not the ceiling,” says Mark Kramer, FSG principal.

“Most large foundations, of course, are explicitly intended to last in perpetuity, as stated in their charter or bylaws,” Kramer writes. “In that case, fiduciary duty includes an obligation to protect the value of the endowment by keeping up with inflation. However, there is no requirement whatsoever to increase the value of the assets beyond the rate of inflation if another course of action would further the donor’s charitable intent. In other words, for private foundations, the normal fiduciary obligation to grow the endowment as much as is prudently possible does not take priority over the charitable mission.”

He goes on to say, “Money may grow over time, but I would suggest that the delayed cost of solving society’s problems grows much, much faster.”

 Nonprofit blogger Vu Lee has been far sharper in his Covid-era critique of endowment payouts in these times. “There are hundreds of billions of dollars in endowments just sitting there because philanthropy has been continuously saving for a rainy day, with most foundations giving out only 5 percent of their assets each year. This means that 95 percent remains untapped, and today is that rainy day.”

He wants foundations to recognize the urgency for change and the opportunity to make a lasting difference. “What we lack is not the funds, but the boldness among foundation leaders to challenge their archaic philosophies and practices, combined with a thorough denial of the reality of this moment,” Lee writes. “Funders, if you don’t think that this pandemic warrants an increase in your payout beyond 5 percent, to 10 percent or 20 percent or more, then you live in a bubble of privilege wrapped in another bubble of delusions.”

Are foundations listening? In June, the Ford, Andrew W. Mellon, Doris Duke Charitable, and the John D. and Catherine T. MacArthur foundations, among others, announced they were taking on more than $1.2 billion in debt in order to substantially increase their combined payout.

Ford announced it would spend 10 percent of its assets this year, others named a dollar amount of increase in the hundreds of millions of dollars to support the sectors in which they’re most active.

We haven’t seen a ripple effect from this timely (and splashy) announcement in Minnesota just yet. Meanwhile, 300 nonprofit leaders—including a dozen or so Minnesotans—are asking Congress to require 10 percent payouts for private foundations and donor-advised funds in each of the next three years.

“There has clearly not been a moment in the past 50 years in which the full deployment of our charitable sector was more necessary. America is in an unprecedented crisis. The world of philanthropy must step up and do more, faster. Congress must insist on it,” their petition states. Ford Foundation CEO Darren Walker agrees, “The greater risk here for foundations is doing nothing,” he’s quoted as saying in The Chronicle of Philanthropy.

What about your own charitable giving or that of your business? Can you afford to step up in these turbulent times? Nonprofit advocates say that the entire sector’s ecosystem is at stake. For them, it’s raining plenty hard enough.

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