An endowment fund is a kind of fund the donors contribute to running the operations of non-profit organizations. Many people relate endowment funds with universities since college endowment funds have the highest market values. However, they are not just limited to universities. Such funds are most notably associated with churches, non-profit charities, hospitals, and community foundations. An Endowment Fund is a financial asset of a non-profit organization. Its invested capital and related income contribute to funding the financial objectives of an Organization. In this blog, you will get a complete overview of the Endowment Fund, its Examples, and how it works.
Did you know? The Harvard University endowment is the world’s biggest educational endowment fund topping the list with around $ 50.9 billion in its endowment. 14000 plus separate funds make up for Harvard’s endowment. It receives 70% of its annual donation from donors donating to specific programs and purposes.
Definition of an Endowment Fund
An endowment is a sum of money or property that a donor contributes to the upkeep of a non-profit organisation. Thus, we can call the non-profit organisation the beneficiary of the endowment fund. The organisation is supposed to utilise this fund for operations consistent with the donor’s wishes.
In other words, it should use the related investment income for a specific program. What makes an endowment fund unique is the fact that the donation amount stays intact. The organisation uses only the investment earnings for charitable works. Endowments serve as the lifeblood of the finances of such organisations.
They are different from typical donations. Carefully managing them allows the organisation to achieve financial stability. Some institutions administer many endowments. They are:
- Educational institutions such as universities and colleges.
- Cultural institutions such as libraries, art museums, and religious organisations.
- Service-oriented organisations such as hospitals.
The donors of endowment funds believe in perpetuity. Since endowments are not subject to tax, the donors can avail of charitable tax benefits by contributing to the fund. The donors can be institutions and individuals. Both cash and kind form part of donations in funding the endowment. These can be stocks, mutual funds, or tangible properties.
On the maturity of the endowment, the donor receives a lump sum amount of money. However, they need not wait for the policy to mature. They have the option to sell their endowment policy before its maturity.
How does the Endowment Fund work?
1) Philanthropic individuals and organisations extend their contributions to form endowment funds. These contributions are in the form of donations, both cash, and non-cash. Thus, they comprise cash, equities, and other securities that yield income in the long run.
Such endowments help the organisation to fund its daily operational expenses and needs, thus providing financial support. The beneficiary adds the donations as part of the fund for investing in them. The generated income from such investments helps the organisation to meet its overall mission and objectives.
2) Different policies govern the subsequent withdrawal from the endowment funds. These policies are- Investment Policy, Withdrawal Policy, and Usage Policy. In some Funds, the organisation is free to withdraw and utilise the principal amount. However, others do not permit the recipient to withdraw the principal amount or a part of it.
3) Donors have the authority to specify the purposes for using the funds. For example, a donor may contribute towards the fund to save poor children from malnutrition. There are four types of endowment funds that come from donors. These are- Restricted Endowments, Unrestricted Endowments, Term Endowments, and Quasi Endowments.
Policies that Govern an Endowment Fund
The following three components govern the Endowment Funds:
- The Investment Policies- These contain policies for investments that the organisation allows the fund manager can make. The Policies focus on asset allocation and targeted income yield. Endowment funds are more liquid as compared to hedge funds and mutual funds. It ensures that amount is readily available for use by the organisation. The organisations legally design the investment Policy to manage the funds for long-term goals and returns.
- The Withdrawal Policies- These contain details on the amount of money an organisation can take out from the fund during each time interval. Most endowments come with a yearly withdrawal limit. The Percentage of withdrawal is generally low to ensure that the organisation can last in perpetuity and has annual spending limits.
- The Usage Policies- These determine the purposes for which the organization can use the fund. The funding should strictly adhere to these purposes without any deviation. Examples of these Purposes are awarding scholarships, scientific research, and other charitable works. It also includes assisting students who have a weak economic background.
Types of Endowment Funds
Endowment funds come in four different sizes; lets figure out each below:
- True or Restricted Endowment: In these funds, a donor can put limitations on the purpose of usage of funds. In other words, the donor specifies the purposes for which the proceeds of the donation can come into use. For example, a restricted university endowment allows organisations to provide fellowships only to students with particular academic achievements.
- The Unrestricted Endowment: In this type of fund, the Donator does not restrict the purpose of the usage of the fund. Hence, the recipient can utilise the money for any of its objectives.
- The Term or Temporarily Restricted Endowment: It is a type of fund that is not available for the day-to-day use of the organisation. The principal amount or part of it is available for use only after a time or the happening of an event. The fund policy predetermines the triggering event, keeping in view the intent of the Donator.
- The Quasi-Endowment: It is a board-designated endowment fund where the governing head of the organisation specifies the purpose that the fund will serve. Since these funds do not exist permanently, the recipient can spend the principal at any time. Though restrictions exist, the governing authority can end them according to their intent. Thus, the quasi-endowment is generally more flexible than the other ones.
Real World Examples of Endowments
The Universities hold the largest endowment funds in the world. They keep aside a portion of the funds to meet their operating expenses. The wealthy Alumni of such universities contribute donations to the fund every year. These donations keep on accumulating year-by-year as a principal balance. It is the responsibility of the fund managers to invest these balances into various investment options. The investment policies of the endowment fund govern these investment options. The earnings from investments help the universities promote academic programs or for the construction of new school premises.
King Henry VIII established the oldest endowments in the form of professorships at Oxford and Cambridge. The chart below lists the top ten universities with the largest endowments at the end of the fiscal year 2021. These are:
- Harvard University- $ 50.9 billion
- Stanford University- $ 37.8 billion
- Yale University- $ 42.3 billion
- University of Pennsylvania- $ 20.5
- Princeton University- $ 37 billion
- University of Michigan- $ 16.8 billion
- University of Notre Dame- $ 18.4 billion
- Massachusetts Institute of Technology- $ 27.4 billion
- Texas A& M University- $ 16.9 billion
- Washington University in St. Louis- $ 13.7 billion
Benefits of an Endowment to the Non-Profit Organisation
The benefits of an endowment fund to the beneficiary include the following:
- Generates a daily source of income- A permanent endowment offers a reliable source of income in perpetuity. In such cases, the organisation can depend on annual donations for charitable purposes. Suitable investment and spending policies preserve the endowment’s purchasing power. Additional gifts from donors keep the endowment growing over time.
- Enhanced financial stability and reputation- A well-managed endowment enhances the prestige and credibility of the organisation by sending a message of planned long-term Financial growth.
- Expansion of Program- Donations to the endowment fund help to expand the program. These programs are scholarships, facility maintenance, faculty chairs, and other purposes.
- Relieves pressure on the annual fund- An endowment supports the organisation’s annual operating budget. The annual fund is well-capable in meeting the increasing financial needs of the organisation.
Endowment funds work on the principle of perpetuity. The Transfer of Property Act, 1882's Section 14 deals with the rule against perpetuity. This rule prohibits transfers that make a property inalienable for an indefinite amount of time because "perpetuity" simply means "indefinite Period."
It is crucial to understand how it works and what benefits it offers to the beneficiary. The organisation reports each type of its endowment on its Balance Sheet. These funds serve the public service missions of the organisations. In this blog, we discussed the meaning of an endowment fund in detail, its policies, types, and how it works.
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