What Is an Endowment and How Does It Work?

What Is an Endowment and How Does It Work?

An endowment is a donation of money or property to a non-profit organization, such as a college, hospital, museum, or religious group. The purpose of an endowment is to provide the organization with an income from the investment of the donated capital. An endowment can also refer to the total of a non-profit institution’s investable assets, which are meant to be used for operations or programs that are consistent with the wishes of the donor(s) .

Most endowments are designed to keep the principal amount intact while using the investment income for charitable efforts. However, some endowments may allow a certain percentage of the principal to be used each year as well . Endowments are typically organized as a trust, private foundation, or public charity . Many endowments are administered by educational institutions, such as colleges and universities. Others are overseen by cultural institutions, such as art museums, libraries, religious organizations, private secondary schools, and service-oriented organizations, such as retirement homes or hospitals .

Endowments usually have three components that govern their investments, withdrawals, and use of funds: investment policy, withdrawal policy, and spending policy. The investment policy lays out which types of investments a manager is permitted to make and how aggressive they can be when seeking to meet return targets. The withdrawal policy establishes the amount the organization is allowed to take out from the fund at each period or installment. The spending policy determines how the withdrawn funds can be used for the organization’s mission and goals .

Endowments can provide many benefits for non-profit organizations and their donors. For organizations, endowments can offer a stable and predictable source of income, reduce dependence on other sources of funding, and enable long-term planning and growth. For donors, endowments can offer a way to support a cause they care about in perpetuity, create a lasting legacy, and enjoy tax advantages .

If you are interested in learning more about endowments or making a donation to one, you can contact your preferred non-profit organization or consult a financial advisor.

There are different types of endowments that vary in their size, structure, and purpose. Some of the common types of endowments are:

  • Term endowment: An endowment that lasts for a specified period of time or until a certain event occurs, such as the death of the donor or the completion of a project. Term endowments may have a lower minimum donation amount than permanent endowments .
  • Quasi-endowment: An endowment that is created by the non-profit organization itself, rather than by an external donor. Quasi-endowments are usually funded by surplus revenues or unrestricted donations. The organization can decide to change or terminate the quasi-endowment at any time .
  • Restricted endowment: An endowment that has specific limitations on how the funds can be used, such as for a particular program, department, or scholarship. Restricted endowments are usually established by donors who want to ensure that their gift is used for a specific purpose .
  • Unrestricted endowment: An endowment that has no limitations on how the funds can be used, as long as they support the general mission and goals of the organization. Unrestricted endowments are usually established by donors who want to give the organization more flexibility and discretion in using their gift .

Endowments are subject to various tax rules and regulations, depending on their type, size, and location. In general, endowments are exempt from income tax, as long as they comply with the Internal Revenue Service (IRS) requirements for non-profit organizations. However, endowments may be subject to excise tax on their net investment income, which is currently 1.39% . Endowments may also be subject to unrelated business income tax (UBIT) if they engage in activities that are not related to their charitable purpose .

For donors, making a gift to an endowment can provide tax benefits, such as deductions for charitable contributions and avoidance of capital gains tax on appreciated assets. However, donors should be aware of the tax implications of their gift, such as the limits on deductions, the valuation of assets, and the reporting requirements. Donors should consult a tax professional before making a gift to an endowment .

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