Endowments are donor-restricted funds that are used to support organizations and pursue other charitable purposes.1 While the nonprofit sector has risen to meet increased demands in the last two years, nonprofits continue to face an uncertain operating environment. Boards responsible for making decisions around spending and asset allocation for endowment funds are returning to a perennial question: how much money should be spent today, versus preserved and invested for tomorrow? 

Consequently, an investment program’s success is commonly measured by its ability to support its spending or distribution policy while preserving purchasing power and allowing for the modest growth of real wealth.

Nonprofit endowments are intended to be a long-term source of financial support. While these endowments have been leveraged to allow nonprofits to be responsive in the face of crisis, planning for institutional longevity requires setting goals and evaluating the financial impact of annual spending and distributions. 

State and federal laws govern the investment and spending of endowed funds. The Uniform Prudent Management of Institutional Funds Act (UPMIFA) has been adopted in various forms across the country.2 When creating a spending policy, the requirements set forth by UPMIFA can help organizations with donor-restricted funds identify the purpose, expected return, and spending policy for the long-term asset pool

In this paper, we focus on the ways nonprofits and philanthropic organizations can use UPMIFA requirements to inform their spending policies.

UPMIFA: Seven Factors for Spending Policy Construction

What is UPMIFA?

UPMIFA was enacted to ensure that charitable institutions had guidelines around the most prudent way to spend endowment funds, which includes appreciated assets and income from those assets

Known collectively as the “prudence standard,” there are seven factors in UPMIFA for institutions to consider as they design their spending rules. 

What are the seven factors for spending policy construction? 

The seven factors focus on: 

1. Duration of the endowment fund

Depending on the original gift agreement that created the endowed fund, there may be provisions around how long the endowment fund should be in existence. Most of the time, the endowment duration will be permanent, but endowed funds can have more limited duration (for example, spend down over 20 years). Spending policies should take into account donor intent related to the time horizon for endowment funds to be used.

Discussion questions for board: Do the governing documents clearly state the donor’s desired duration for the endowment? Is the spending policy for the endowment in alignment with that duration? If not, what would need to change?

2. Purpose of the institution and its endowed funds

Charities have a duty to use endowed funds for charitable purposes while complying with donor intent. To use an example, an endowed scholarship fund at an educational institution should have a spending policy designed to offer student support in a way aligned with the donor’s intent. 

Discussion questions for board: Does the spending policy currently in place align with donor intent? Organizational mission? What would need to change if that is not currently the case?

3. General economic conditions

The general economic conditions factor can be used to consider how a given spending policy does – or does not – help preserve the principal of endowment assets. When designing a spending policy, it is important to consider ways to take general economic conditions into account when calculating spend in a given period. UPMIFA does not give a comprehensive list of general economic conditions beyond those “an ordinarily prudent person” would consider.3

Discussion question for board: Does the spending policy provide the organization with adequate flexibility to factor in general economic conditions when calculating spend? 

4. Potential effects of inflation or deflation

UPMIFA specifies that spending policies should take the potential effects of inflation or deflation into account. Spending policies can have an impact on both spending – in dollar terms – and on the principal of an endowed fund. In an environment with rising inflation, if the return on assets does not exceed the annual spend plus inflation, the purchasing power of the endowment may decrease (and result in distributions with lower purchasing power in the future).

Discussion questions for board: Does the spending policy allow the organization to take inflation into account? In an inflationary or deflationary environment, how might spending shift under the current policy? Is the organization comfortable with the potential level of spending volatility under those scenarios?

5. Expected total return of the endowment

Endowment funds are often invested in a way to maximize their total return from interest, dividends, other income, and net capital gains. Accordingly to the National Conference of Commissioners on Uniform State Laws, UPMIFA’s spending policy guidance is oriented around assuring “generational equity,” or ensuring that spending to support future generations can occur with a similar level of purchasing power as support for current ones.4 When designing a spending policy, it is important to be aware of the expected total return – based on target asset allocation – and whether or not the spending policy will enhance or impair the purchasing power of the endowment over the long term. Total return should be greater than the effective distribution rate to preserve generational equity.

Discussion questions for board: Based on the duration of the endowment and its expected total return over that period, how does the spending policy help – or hurt – generational equity for the endowment? Does the organization have a clear understanding of the expected total return of the endowment over the long term?

6. Organizational resources

Endowed funds are just one type of resource that nonprofit organizations can use to accomplish their mission. Many organizations also have shorter-term assets, real estate, and other types of long-term asset pools that they can use to pursue opportunities and respond to challenges. Since endowed funds are donor restricted, they often do not provide as much liquidity and flexibility as other parts of nonprofit capital structure might. When designing a spending policy, it’s important to understand broader organizational financial history and anticipated resource needs. 

Discussion questions for board: Given the historical financial position of the organization and anticipated resource needs, what are some potential challenges around managing the endowment that may arise? Are there situations that may place pressure on the endowment and periodically prompt greater (or less) spend – and does the current policy take that into account? 

7. Organizational investment policy

Aside from annual distributions, asset allocation – which is outlined in an investment policy – has a significant effect on expected total return. Identifying a sustainable distribution rate for an endowment can often begin by understanding whether allocations to equity, fixed income, and alternatives align with aspirations for spend.

Discussion questions for the board: Does the current investment policy support the spending policy? What are implications of the short and long-term expected total return for annual spend? Is there any implied shortfall risk – and is there a decision-making process in place to handle that situation if it arises? 

Key Takeaways

1. Determine if UPMIFA applies to your organization and situation

UPMIFA doesn’t apply to every nonprofit organization, and may be subject to different rules established by their governing documents or state law. Private foundations held by individual or commercial trustees, for example, are governed by their founding documents and applicable state trust law.

To determine if UPMIFA applies to your organization, we recommend consulting a legal services firm experienced in nonprofit law in your state.

2. Evaluate your current spending policy against the seven factors outlined by UPMIFA

Using the discussion questions in this paper, reflect on your spending policy. Context is an important part of identifying a spending policy that supports your organizational goals and vision for impact while fulfilling donor intent. Organizational financial health, current and future resource needs, and mission impact targets can give boards the inputs needed to design a spending policy from a holistic point of view.

3. Document your spending policy in your investment policy statement and establish a process for ongoing review

We recommend documenting your organization’s spending policy in an investment policy statement. This can help to instill discipline in every step of the process, including portfolio construction, scheduled distributions, and ongoing strategic reviews.

Spending Policy Construction: Hypothetical Examples

There are a variety of ways to incorporate the 7 factors outlined in UPMIFA into an organizational spending policy. Below, we outline three sample spending rules that can serve as a starting point.

Sample Spending Policies

[Simple Spending Rule]

The long-term annual spending and distributions from the fund are targeted to average _______ (xx%) of the beginning period market value of the fund. However, spending and distributions may occasionally exceed this amount as necessary as determined by [__________________________].

[Rolling Three-Year Average Spending Rule]

While the long-term annual spending and distributions from the fund are targeted to average _______ (xx%) of a moving 12-quarter market value average of the fund, spending and distributions in any one fiscal year may range between a minimum of ____ (xx%) and a maximum of ____ (xx%). However, spending and distributions may occasionally exceed this amount as necessary as determined by [__________________________].

[Geometric Spending Rule]

The long-term annual spending and distributions from the fund are targeted to average _____ (xx%). Spending in the current period is equal to: a) previous year’s distribution adjusted for inflation times a smoothing rate of [______], plus b) the beginning market value of the portfolio times the spending rate and the residual of the smoothing rate [______]. However, spending and distributions may occasionally exceed this amount as necessary as determined by [___________________________].

About the Endowment & Foundation National Practice Group

The Endowment & Foundation National Practice Group builds on PNC Bank’s longstanding commitment to philanthropy and is focused on endowments, private and public foundations, and nonprofit organizations. We seek to help these organizations address their distinct investment, distribution, and capital preservation challenges.

For more information, please contact Henri Cancio-Fitzgerald at henri.fitzgerald@pnc.com.

 

  1. National Conference of Commissioners on Uniform State Laws. “Uniform Prudent Management of Institutional Funds Act.” Uniform Law Commission, 8 Nov. 2007, https://www.uniformlaws.org/HigherLogic/System/DownloadDocumentFile.ashx?DocumentFileKey=d88fe964- fa49-9b1e-e197-2389fcc49990&forceDialog=0.
  2. To understand the nuances of specific state versions of UPMIFA, an organization should consult its legal advisor to understand how a given state’s version of UPMIFA may apply
  3. “Prudent Management of Institutional Funds Act - Uniform Law Commission.” Prudent Management of Institutional Funds Act - Uniform Law Commission, www.uniformlaws.org, https://www.uniformlaws.org/committees/community-home?CommunityKey=043b9067-bc2c46b7-8436-07c9054064a3. Accessed 11 April 2022. 
  4. National Conference of Commissioners on Uniform State Laws. “Uniform Prudent Management of Institutional Funds Act.” Uniform Law Commission, 8 Nov. 2007, https://www.uniformlaws.org/HigherLogic/System/DownloadDocumentFile.ashx?DocumentFileKey=d88fe964- fa49-9b1e-e197-2389fcc49990&forceDialog=0.