We have previously written about prudent investment rules that apply to charities with respect to their institutional funds (including endowment funds) under the Uniform Prudent Management of Institutional Funds Act (UPMIFA), including here. One of the important factors in selecting and managing investments is the amount that is intended to be expended and the frequency of such expenditure. The expenditure or spending amount is also subject to limitations set by UPMIFA, which is generally applicable to all states, except Pennsylvania, and the District of Columbia.

UPMIFA and Spending Limits

(a) Subject to the intent of a donor expressed in the gift instrument [and to subsection (d)], an institution may appropriate for expenditure or accumulate so much of an endowment fund as the institution determines is prudent for the uses, benefits, purposes, and duration for which the endowment fund is established. Unless stated otherwise in the gift instrument, the assets in an endowment fund are donor-restricted assets until appropriated for expenditure by the institution.  In making a determination to appropriate or accumulate, the institution shall act in good faith, with the care that an ordinarily prudent person in a like position would exercise under similar circumstances, and shall consider, if relevant, the following seven factors (the “7 Spending Factors”):

1. the duration and preservation of the endowment fund;
2. the purposes of the institution and the endowment fund; 
3. general economic conditions; 
4. the possible effect of inflation or deflation; 
5. the expected total return from income and the appreciation of investments; 
6. other resources of the institution; and 
7. the investment policy of the institution. 

(b) To limit the authority to appropriate for expenditure or accumulate under subsection (a), a gift instrument must specifically state the limitation. 

(c) Terms in a gift instrument designating a gift as an endowment, or a direction or authorization in the gift instrument to use only “income”, “interest”, “dividends”, or “rents, issues, or profits”, or “to preserve the principal intact”, or words of similar import:

1. create an endowment fund of permanent duration unless other language in the gift instrument limits the duration or purpose of the fund; and
2. do not otherwise limit the authority to appropriate for expenditure or accumulate.

[(d) The appropriation for expenditure in any year of an amount greater than seven percent of the fair market value of an endowment fund, calculated on the basis of market values determined at least quarterly and averaged over a period of not less than three years immediately preceding the year in which the appropriation for expenditure is made, creates a rebuttable presumption of imprudence.  For an endowment fund in existence for fewer than three years, the fair market value of the endowment fund must be calculated for the period the endowment fund has been in existence.]

Thoughts About Spending

Generally, donors who make contributions specifically for the endowment of an organization are reasonably presumed to have preservation of their contribution as a motivating factor for making the contribution. So, UPMIFA attempts to protect the donor’s intent. It provides that, absent a conflicting provision in the gift instrument, charities can’t spend more than what would be prudent after consideration of the 7 Spending Factors, to the extent each is relevant. UPMIFA may also provide, in optional subsection (d) (see above), that spending more than seven percent of the endowment’s value is presumptively imprudent. This optional provision is included in California’s version of UPMIFA (Probate Code Sections 18501 – 18510).

The general rationale for these spending limitations is to preserve the value of the donor’s contribution while ensuring reasonable spending, which may come out of the income produced by the contributed assets. In theory, that could keep the endowment contribution stable indefinitely if we can assume it will always generate net income sufficient to support the organization’s spending policy. Of course, some contributions may not produce income, and some years, the endowment may actually decrease in value.

When a charity and donor choose not to describe the charity’s endowment fund or the contribution to the endowment with more specificity, it may be that the donor’s intent matches up with the law that preceded UPMIFA and known as the Uniform Management of Institutional Funds Act (UMIFA). Under UMIFA, preservation of the historic dollar value (e.g., the cumulative endowment contributions) might arguably be a purpose of the endowment fund and therefore part of the 7 Spending Factors. While it seems unlikely that a charity would be required to comply with the old law based on any undocumented assertion of a donor’s past intent, the charity might need to consider donor and public relations and trust factors and not just the law.

The gift instrument exception to the default requirements under UPMIFA should be considered in designing the nature of the fundraising initiative or the gift. Either the charity, in its solicitation, or the donor, in their gift instrument, could set forth a specific purpose of the endowment fund that would supersede the default requirements under UPMIFA. For example, the donor could set forth a minimum spending amount higher than the seven percent figure. Or, more rarely, the charity could solicit contributions to an endowment fund that makes annual distributions of such higher amount, which might be part of its spend-down or limited existence strategy.

Calls for Spending Endowment Funds

Many communities have demanded that certain nonprofits manage their endowment funds with more of a ‘spend-now’ focus than a growth focus. A few of the wealthier colleges and universities have even been accused of being more like investment companies with a side educational business than a school with investments. And, during the worst part of the COVID pandemic, many foundations were criticized for warehousing their wealth rather than increasing their spending to address urgent needs despite their claims that endowment funds were necessary for ‘rainy days.’

While such criticisms may have considerable merit, the solutions are not so simple, in part, because of the spending rules described above. If spending more than seven percent of the fair market value of an endowment fund is presumptively imprudent, what is sufficient to rebut the presumption and justify spending more? And how much more?

If a board gets it wrong, could a state charity regulator hold the board members accountable and even remove them from the board? While this seems very unlikely absent a diversion of charitable assets to benefit individual board members, board members of some public charities (including colleges and universities) could be privately removed or pressured to resign by critics of diminishing an endowment’s value.

So, we’re left with some intriguing questions about how much more than the presumptive spending limit would be justified by a charity’s desire:

• to address the COVID pandemic;
• to address a disaster with immediate impact to the charity or its ability to advance its mission;
• to address climate change, assuming recognition of the impact it will have on the charity, its mission, its values, its beneficiaries, and its communities*;
• to address student debt; or
• to address threats to our democracy.

Climate Change

Prudent Investments: UPMIFA and Climate Change

What’s Your Nonprofit Doing to Fight Climate Change?

Purpose-Driven Board Leadership and Climate Change

More on Nonprofits and Climate Change

Colleges and Universities

College and University Endowments: Payout Rates and Spending on Student Financial Aid (March 22, 2023, Congressional Research Service)

College and University Endowments (The Commission on Independent Colleges and Universities)

College Endowment Returns Ticked Up in Fiscal Year 2023 (Inside Higher Ed)