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    Trusts & Estates (Endowments)

 

  • Endowments can be an effective financial planning tool for not-for-profit entities both large and small, ensuring that the charitable works of any such entity will be funded properly for many years into the future, so such entities may carry on their charitable works missions without fear of a sudden loss of funding.

 

  • In general, endowments are considered to be donor-restricted funds (meaning that the donor has placed conditions on how the donee – the entity receiving the donation – may use the money generated by the donation), comprised of assets (generally one large cash amount or an aggregate of many smaller cash accounts that may be invested in equities or bonds, or other investment vehicles to spin off earnings such as interest) that may be donated by an individual, or individuals, or a corporate entity, or corporate entities to a charitable entity (such as a not-for-profit corporation or charitable trust), in which the original principal assets of the donation (generally known as the “corpus”) are not touched (generally known as "restricted assets"), depending upon how the endowment is structured (as determined by the written instructions of the donor or donors), so that the principal remains intact and only the earnings may be used for charitable works or to be invested, thus increasing the value of the endowment (again,as determined by the written instructions of the donor or donors).

 

  • As far as how much might be prudent as the original principal donation for an endowment, there is no set amount, but some experts have suggested that a minimum amount for an endowment may be at least twice the annual operating budget of the not-for-profit entity that seeks to have the endowment.

 

  • An endowment may be set up within an existing not-for-profit entity, or it may be spun off from such entity into a separate Internal Revenue Service (IRS) Internal Revenue Code (IRC) 501(c)(3) tax-exempt organization or foundation.

 

  • The basic steps to forming an endowment – whether as a permanent unrestricted endowment (where all the endowment assets can be distributed, invested, saved or spent at the sole discretion of the institution receiving the gift, as long as any endowment funds may last), or as a term endowment (that allows only the earnings generated by the endowment principal to be expended for charitable purposes for a certain specified term, and then the original principal may also be expended as well), or as a quasi-endowment (in which the endowment is intended only for a specific charitable purpose, and the principal is generally left untouched, with only the earnings on the principal being used for the specified charitable purpose), or as restricted endowment (in which the endowment principal must remain untouched in perpetuity, and only the earnings generated by the principal and any subsequent donations may be used to fund the donor's specified charitable purpose), and regardless of how the endowment may be organized (generally as either a private foundation, public charity or trust) – may be categorized generally as: first, implementing a stable business plan for the not-for-profit entity for which the endowment is intended, that is based on responsible and prudent financial planning principles and skilled management by professional individuals and entities with years of experience in the financial planning industry – in general, planning for the endowment should include the ability for the subsequent endowment contributions and earned interest to cover all the operating expenses of the endowment (generally such as fees for accounting, banking, legal and management), without having to "invade" (meaning to deduct money from) the "corpus" (meaning the original principal amount of the monetary gift from a donor fund the endowment); second, convincing the Board of such not-for-profit entity and all potential donors to such not-for-profit entity of the need for an adequate cash-reserve fund (an account containing working capital sufficient enough to ensure the continuing operations of such not-for-profit, since many not-for-profit managers feel that a not-for-profit should concentrate all available cash on fulfilling the chosen charitable works of the not-for-profit, and taking care of operating expenses only from whatever cash may be left over at any particular moment), before subsequently addressing the concept of creating an endowment – similar guidance to the "Working Capital Ratio", one of the criteria established by the CharityNavigator watchdog agency that rates charities to gage how long a charity's charitable programs may be able to continue without any infusion of new cash donations; third, once all are convinced that a cash reserve fund ins necessary, then establish both that cash reserve (assuming the not-for-profit entity does not already have one) and an endowment fund – in this way it will be clear to both potential donors and the managers of the not-for-profit entity that the cash reserve is intended to cover operating expenses, and that the endowment corpus is intended to be a "restricted asset" (meaning that the corpus must remain untouched, and only the generated interest and subsequent donations may be used to fund only charitable works of the not-for-profit entity, assuming that is the specified written intent of the donor); fourth, hire competent investment professionals, whether individuals or firms – such as those who may have the Registered Investment Advisor (RIA) certification –  to manage both the cash reserve fund and the endowment; and fifth, let potential donors know about the responsible and prudent financial planning corporate policies the not-for-profit has established, when embarking on any fundraising activities, so that the confidence of potential donors about dealing with such not-for-profit will be increased.

 

  • New York Consolidated Laws, Not-For-Profit Corporation Law – NPC Article 5-A, entitled the "New York Prudent Management of Institutional Funds Act" (“NYPMIFA”) is the New York State version of the Uniform Prudent Management of Institutional Funds Act (“UPMIFA”), and governs the management and investment of funds, including endowments, held by not-for-profit corporations and other institutions within the State of New York.

 

  • Very importantly, under NYPMIFA Section 553(a), unless stated otherwise explicitly by the donor in the donor's gifting instrument, the assets in an endowment fund are considered to be donor-restricted (meaning that it must remain untouched) until they are “appropriated for expenditure” by the appropriate financial managers.

 

  • NYPMIFA also presents some significant deviations from any previous laws governing endowments, such as under NYPMIFA: endowment entities are allowed to spend endowment funds below the original dollar amount (generally known as the “historic dollar value” or "Principal" or "corpus") by "invading" (taking from) the historic dollar value without court approval or Attorney General review, providing that the endowment entity's Board concludes (after careful analysis of certain considerations enumerated in NYPMIFA) that such spending is prudent (NPC Section 553); NPC Section 552(e)(1) requires that all investments must be diversified, to cushion the impact of economic downturns, unless the institution prudently determines that, because of special circumstances the purposes of the fund are better served without diversification;  there are eight (8) specific standards for what may be considered the prudent management and investment of institutional funds (NPC Section 552); the delegation of management and investment functions to qualified outside advisors is permissible (NPC Section 554); procedures are established for removing or modifying (generally known as "reformation") any donor-imposed restrictions (even if the donor is still alive but does not consent) on the management, expenditure or use of such funds (NPC Section 555); Section NPC 553(a) requires Boards to make a determination whether it may be appropriate to consider other alternatives before deciding whether to authorize expenditures from an endowment fund; NPC Section 552(f) requires every institution to adopt written investment policies based on ten (10) factors, setting forth specific guidelines on investments and delegation of management and investment function; and, NPC Section 553(e)(1) requires that notice must be given to available donors who executed a gift instrument before September 17, 2010, that allows such donors to opt out of the new NYPMIFA rule noted above permitting institutions to spend below the historic dollar value of the endowment.

 

  • One oddity of NYPMIFA is found in NPC Section 553(d), creating a "rebuttable presumption of imprudence" if the endowment financial managers appropriate an aggregate of more than seven percent (7%) of the endowment fund's fair market value (there is apparently no official explanation of how the 7% threshold was determined) in any one-year period for expenditure (meaning that in such a situation, the financial managers would be required to prove that they were not imprudent by making such appropriations).

 

  • NYPMIFA also amends the New York Consolidated Laws, Executive Law – EXC, Section 174-b[2], to require a specific disclosure to donors when anyone solicits donations on behalf of an endowment fund to the effect that unless otherwise restricted by the gift instrument pursuant to NPC Section 553(b), the financial managers of the endowment fund may expend as much of the endowment fund as they deem prudent, after considering the factors governing financial decisions specified in NPC Section 553(a).

 

  • NYPMIFA reinforces guidance from the Financial Accounting Standards Board (FASB) standard FAS 117-1, requiring organizations to classify the income and appreciation from a donor-restricted endowment fund as temporarily-restricted, rather than as unrestricted (as was previously allowed), until such time as the Board makes a determination (after consideration of all the relevant decisional factors specified in the NYPMIFA) that any such funds may be prudently and reasonably appropriated for expenditure.

 

    Last updated 201008_2014

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