Endowments and Prudent Management of Institutional Funds

How much a charity may spend from an endowment, and how it must invest the money in the meantime, is answered by state law — specifically by the Uniform Prudent Management of Institutional Funds Act, adopted in nearly every state. Its central move was to abolish the old rule that barred spending a fund below its historic dollar value, the total of the original contributions. In its place the act sets a prudence standard: the institution may appropriate for expenditure so much of an endowment fund as it determines is prudent for the uses and purposes for which the fund was established, after considering a list of stated factors.

1.What changed and why

Under the older regime, a fund that fell below the sum of the original gifts was said to be underwater, and the institution could spend only income — interest and dividends — until the corpus recovered. That produced two distortions. It pushed institutions toward income-producing assets rather than a balanced portfolio, and it froze spending on precisely the programs the donor had funded, at precisely the moment they were most needed.

The uniform act, developed through the drafting process described by the Uniform Law Commission, replaced the accounting floor with a judgment. It also directed institutions to invest under a modern portfolio approach and to consider the fund's purposes, the institution's other resources, and general economic conditions when deciding what to spend.

The result is more flexibility and more responsibility. There is no longer a mechanical rule to hide behind, which means the deliberation and its documentation carry the weight that the old floor used to carry.

2.The spending decision

The act lists factors the institution must consider when appropriating from an endowment fund. Each should appear in the committee's record, whether or not it moved the outcome.

• The duration and preservation of the endowment fund.
• The purposes of the institution and of the fund.
• General economic conditions.
• The possible effect of inflation or deflation.
• The expected total return from income and appreciation of investments.
• Other resources of the institution.
• The investment policy of the institution.

Several states added a rebuttable presumption of imprudence for appropriations above a stated percentage of the fund's average fair market value over a trailing period. That percentage and the presumption itself are state-specific — some states adopted it, some rejected it, and at least one adopted a variant — so the enacted text of the state's own version has to be read rather than the uniform draft.

Caution: A gift instrument can override the default rules. Language directing that only income be spent, or setting a fixed distribution, controls over the statute's default. Read the actual instrument for each fund before applying a single institution-wide spending policy to all of them.

3.Investment duties

The act imposes a prudent investor standard adapted to charitable institutions. Decisions about individual assets are evaluated not in isolation but in the context of the portfolio as a whole and as part of an overall investment strategy with risk and return objectives reasonably suited to the fund and to the institution.

1. Adopt a written investment policy. Objectives, asset allocation, rebalancing discipline, liquidity needs, and any mission-related screens the board has approved.
2. Diversify. Unless the institution reasonably determines that special circumstances make the purposes of the fund better served without diversification.
3. Review contributed assets. Within a reasonable time after receiving property, decide whether to retain or dispose of it in order to bring the portfolio into compliance with the policy.
4. Manage costs. Incur only costs that are appropriate and reasonable in relation to the assets, the purposes, and the skills available to the institution.
5. Delegate carefully. Selection, instruction, and periodic review of an external manager are themselves duties; delegation transfers the work, not the responsibility for choosing well.
6. Document. Minutes recording the strategy, the reasoning, and the review cycle.

These duties belong to the same fiduciary family as the general board obligations set out in nonprofit board duties and conflict-of-interest policies, and the conflicts discipline applies with particular force where a committee member is connected to a manager under consideration — a situation that can slide into the territory described in private inurement and excess benefit transactions.

4.Restrictions and their release

A donor restriction is not permanent in every circumstance, but releasing one is a formal act. The act provides three routes, and a fourth exists in most states outside it.

The dollar and age thresholds for that last route are set separately by each state and differ, so the enacted section rather than a national summary is the source. Notice to the attorney general is a common thread across the routes, reflecting that office's role as the enforcer of charitable interests.

5.Reporting and classification

Endowment activity is reported publicly. The annual return series described on the IRS Form 990 page includes a schedule for endowment funds showing beginning and ending balances, contributions, investment earnings, grants, administrative expenses, and the split among permanent endowment, term endowment, and board-designated funds.

That last category is worth naming precisely. A board-designated or quasi-endowment is money the institution chose to treat as endowment. It carries no donor restriction, the board can undesignate it, and it is not subject to the release procedures above. Confusing board-designated funds with donor-restricted ones, in either direction, causes both accounting errors and legal ones.

Federal tax law affects endowments in narrower ways: exemption itself rests on 26 U.S.C. 501, private foundations face their own distribution requirements, and certain large educational institutions are subject to a separate excise tax on net investment income. General federal guidance sits at the IRS charities pages, while the governing state statute is located through the state's own code — attorney general charity offices are reachable via USA.gov.

6.Questions this raises

Can a charity spend from a fund that is worth less than the gifts it received?

In enacting states, yes in principle, because the historic dollar value floor is gone and the question is prudence. Some states require additional disclosure or impose a presumption against larger appropriations from such funds. The committee should record why the appropriation serves the fund's purposes and how it weighed preservation of the fund against current need.

Does the act apply to a charitable trust with a bank as trustee?

Often not. The definition of institutional fund generally excludes funds held for an institution by a trustee that is not itself a charitable institution. Those arrangements are governed by trust law, including the state's prudent investor act and the terms of the trust. Identifying which body of law applies is the first step, and it is frequently assumed rather than checked.

Who enforces the spending and investment rules?

Primarily the state attorney general, acting on behalf of the charitable interest. Donors generally lack standing to sue over the management of a completed gift unless the gift instrument expressly reserved enforcement rights, and a few states have modified that rule by statute. This is one reason donors negotiating major gifts sometimes ask for standing language.

Should a spending rate be fixed in the investment policy?

A stated methodology helps, provided it is applied as a starting point rather than an answer. Many institutions use a percentage of a trailing average market value to smooth volatility. The statute still requires consideration of the listed factors each time, so a policy that runs automatically without any recorded deliberation weakens the very record it was meant to create.

7.Working order

Inventory the funds first. For each one, locate the gift instrument, record the exact restriction, note the date and original amount, and classify it as donor-restricted or board-designated. Institutions that have merged, moved, or changed staff repeatedly often cannot find the instruments, and reconstructing intent from acknowledgment letters is a poor substitute.

Then read the state's enacted version of the act rather than the uniform text, checking whether it adopted the percentage presumption, what thresholds it set for the small old fund release, and what notice the attorney general requires. Those three points are where enacted versions diverge most.

Finally, align the calendar: investment policy review annually, appropriation decisions on a fixed schedule with the statutory factors recorded, and reconciliation of the endowment schedule on the annual return against the underlying fund ledger. The most common finding in an endowment review is not imprudent spending but an inability to show how the number was reached.