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What Is an Endowment, and How Do They Work?

Sam Lipscomb

What Is an Endowment

An endowment is comprised of money donated to a non-profit organization. This sum of money is typically placed in an endowment fund, which is then invested. The return from those investments are used to fund the organization’s operations or grow the endowment principal.

What Is an Endowment?

Endowments are investment vehicles that generate income for non-profit organizations. They are often set up as a trust, private foundation or public charity.

An organization with an endowment, such as a college or university, will invest this money to generate a return that can help fund its various needs. Endowments typically have a board of trustees that makes decisions regarding the endowment, as well as an investment committee and investment manager.

Endowments are often set up so that the principal remains untouched, despite return on endowments being fairly modest (usually around 5%). The idea is to provide a steady stream of capital to the organization, on top of other donations and income.

Most endowments cap the amount of money that they’ll spend from their investment returns every year. Returns above that threshold are consequently reinvested into the endowment. When returns fall below that mark, the organization may dip into the principal to cover costs.

Endowments are a popular way for donors to give money and support to organizations that they care about. However, a major advantage of donating to an endowment is the fact that donations are almost always tax deductible. As a result, endowment donations often fit in with donors’ financial planning decisions quite well.

What Are the Different Types of Endowments?

There are four different types of endowments:

  • Unrestricted endowments: These can be used at the discretion of the organization. Both the principal and the earnings go towards whatever that organization agrees upon.
  • Restricted endowments: These are much more limited than their unrestricted counterparts. For these, the principal cannot be touched, and the earnings must be spent as the donor stipulates.
  • Term endowments: For these, the principal is held in perpetuity for a predetermined period of time.
  • Quasi endowments: These start with an express purpose, such as for an educational scholarship or a particular department of a museum. Quasi endowments share significant similarities with restricted endowments.

An unrestricted endowment is preferable for those managing the endowment of any non-profit organization. That being said, most organizations utilize multiple endowment types. As far as donors are concerned, this variation gives them ample choice when deciding what to invest in.

What Types of Organizations Use Endowments?

University endowment

The most common version of an endowment is a college or university endowment. Typically, these educational organizations operate an endowment that anyone can donate to. Colleges and universities may sometimes have quasi endowments as well for scholarships and specific programs and majors. Private primary and secondary schools may also have endowments which can be used to provide financial aid, upgrade facilities and undertake other projects.

Museums, charities and other non-profit organizations customarily have endowments too. Similarly, these allow donors to fund their preferred organizations as a whole, or donate to specific projects or departments. For-profit organizations cannot have endowments.

How to Start an Endowment

Starting an endowment for a growing organization is simpler than you might think. You can start an endowment at any size. Growing it can be looked at as a long-term project.

The board of your organization should start by specifying the terms of the endowment. You’ll need to pick what kind of endowment it is, name it, restrict its use and more. While setting up an endowment isn’t difficult, it would be wise to work with a lawyer or financial advisor to ensure that everything is done correctly. Many advisors specialize in working with non-profit organizations and their endowments.

Finally, you’ll want to start raising money for your endowment. You can do so through marketing and the creation of planned-giving programs. Keep in mind that immediate fundraising needs should usually take priority over raising money for your endowment.

Bottom Line

What Is an Endowment

Endowments are a key component of how non-profit organizations generate donations, income and, in turn, support. While most endowments only garner roughly 5% in annual returns, this can cover a significant portion of a non-profit’s overall operating expenses.

The bigger the endowment, the more an organization can earn on an annual basis, so it’s easy to see why so many non-profit organizations put such a heavy emphasis on growing their endowments. What’s more, endowment donations are tax deductible, making them attractive investment opportunities.

Investing Tips

  • Whether you’re managing the endowment of a non-profit or just considering donating to one, it’s a good idea to seek the guidance of a financial professional Finding the right financial advisor that fits your needs doesn’t have to be hard. SmartAsset’s free tool matches you with financial advisors in your area in 5 minutes. If you’re ready to be matched with local advisors that will help you achieve your financial goals, get started now.
  • The creation of an asset allocation is one of the best ways to ensure that your investment portfolio falls in line with your risk tolerance, time horizon and overall investment objectives. If you’re unsure where to start, stop by SmartAsset’s asset allocation calculator.

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