Planning for Sustainability: Securing Endowments and Planned Giving Arrangements
Learn about endowments and planned giving arrangements, two types of long-term funding that can benefit both donors and the organizations receiving gifts.
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WHAT ARE ENDOWMENTS AND PLANNED GIVING ARRANGEMENTS?
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WHY WOULD YOU WANT TO SECURE ENDOWMENTS OR PLANNED GIVING ARRANGEMENTS?
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WHEN SHOULD YOU TRY TO SECURE ENDOWMENTS OR PLANNED GIVING ARRANGEMENTS?
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HOW DO YOU SECURE ENDOWMENTS AND PLANNED GIVING ARRANGEMENTS?
Let’s dream a little. You’re the director of a small or medium-sized community based organization. Like all such organizations, it’s strapped for money, and you’ve been spending most of your time looking for funding, both from state agencies and from the community. Then, one morning, you get a phone call.
It’s an attorney with a wealthy client who’s looking for an organization to which to donate a large amount of money...a large amount of money. What kinds of plans do you have to handle such a donation? If you can offer something attractive, his client would be inclined to give you a gift considerably larger than any you’ve imagined. Would you be ready with an answer? More to the point, what would you do with a very large donation?
Large non-profit organizations and institutions – nation-wide charities, universities, hospitals, large churches – look for and receive major donations, sometimes in the millions of dollars. They know exactly what to do with them: Some of the gifts go to specific programs or needs, but more go into an endowment that supports the organization or institution over the long term, or into planned giving arrangements that allow donors to use their charitable contributions as investments.
Although universities and other large non-profits have the resources to maintain development offices to find and manage major contributions, smaller entities may still be able to provide major donors with some options – and in the process provide themselves with the resources to sustain their work despite the ups and downs of funding.
This section is about endowments and planned giving arrangements – two types of long-term funding that can benefit both donors and the organizations that receive their gifts. We’ll look at what they are, how to establish and administer them, and also consider how to persuade donors to contribute to them.
WHAT ARE ENDOWMENTS AND PLANNED GIVING ARRANGEMENTS?
Before we begin, two disclaimers:
1. This section will help you understand what endowments and planned giving arrangements are, as well as some of the possibilities they may offer for your organization. Be aware, however, that federal and state tax laws and the state laws regulating (or not regulating) these arrangements are complex, and the Community Tool Box does not mean this section to be more than general information. If you want to set up an arrangement for large donations, we strongly advise you to do it with the help of someone who knows the territory – a development professional, an investment analyst, a lawyer, or an accountant who’s actually had experience creating and working with these kinds of plans.
Be aware also that in order for donors to benefit from the tax advantages that many of these plans offer, your organization or institution has to have 501(c)(3) or other appropriate non-profit tax statusfrom the Internal Revenue Service. Not every non-profit status is eligible, and you should make sure that yours is one that allows tax deductions or credits for donors. (The IRS website, has information on which designations qualify for tax-deductible contributions.
2. In general, endowments and planned giving arrangements work best when there are major donors available, and when an organization has the resources of knowledge, personnel, and finances to set them up, manage, and maintain them. Those basic requirements usually eliminate small grass roots organizations...but not always.
Although most of the information in this section is more likely to be useful to large organizations with relatively sophisticated financial capabilities, there is at least one possibility here for small organizations as well. A community-based organization may only need two or three gifts that would be considered small by a university or museum in order to put together an endowment that will yield a few thousand dollars a year, and make the organization’s life a great deal easier. A few gifts of between $1,000.00 and $10,000.00 – not totally impossible for a small organization, although not easy, either – donated over time and left to grow for ten years or so, can produce enough income to make a real difference in the extent or quality of the work the organization can do.
That said, the amount of work involved in planned giving arrangements, the regulations governing them, the investment skills needed to make them profitable, and the fact that they need a considerable amount of capital to get them started usually make them more than a small organization can or should handle. Working to create an endowment, or persuading local donors to name the organization in their wills may well be worth the effort; trying to take on planned giving probably is not.
(A possible exception is an arrangement whereby a number of smaller organizations join forces to create a joint planned giving program. Such a group could hire a professional or a firm to set up and manage the fund, and could split the income from it according to some formula that they had worked out beforehand, or according to the wishes of donors. This is similar in some ways to a community foundation, which both solicits contributions and manages or receives large sums from small foundations or individuals, which it then distributes to local organizations. The difference is that the group that offers the planned giving program would reap all the benefit, rather than having to apply for funding, as it would with a community foundation.)
- Endowments. An endowment is, quite simply, a fund built up from donations (or sometimes from a single large donation) to a non-profit. The principal (the original sum) of the fund is invested, and the income is used to fund the activities of the organization or institution. Usually, some of the income is also reinvested, allowing the principal to grow, so that the endowment becomes larger over time, and produces more income.
An endowment may benefit the whole organization or institution, or it may be earmarked for a particular program or activity. In a university, for instance, particular professorships may have their own endowments (usually the gift of a single donor). In a hospital, the cancer clinic or research on diabetes treatment may be supported by an endowment intended only for that purpose.
Large institutions often offer donors the option of contributing to the general endowment or to one of several more narrowly focused ones. Major donors may have their own ideas about what they want to endow, and it is unusual (although not unknown) for an institution to turn away money that a donor earmarks for her own pet project. (It is not unusual, however, for a major donor to have the program or building or professorship that her gift made possible named after her or someone she designates.) Among the conditions that a donor might place on an endowment contribution are that the income should not be used until the principal reaches a certain amount, or that a certain percentage of income has to be spent (or, alternatively, reinvested) each year.
A gift to an endowment might take any one (or more) of several forms:
- Cash
- Securities (stocks and bonds.)
- All, or a percentage of, the income from a property or concession (rent from a large office building, income from a producing oil well, etc. In such a case, the donor would retain ownership of the property or concession, and the donation might be time-limited – perhaps, for instance, going back to the donor’s heirs at her death.)
- Real estate (buildings or land or both.)
- Personal property (artwork, collections, antiques, or other valuable items.)
The timing of a gift can also take a number of forms:
- A one-time lump sum.
- Stretched out over several years for tax purposes (more about this later).
- A bequest in a will, starting only at the donor’s death.
- Time-limited (ending with the donor’s death, or after a specified number of years.)
- Only available when the principal reaches a certain level
- Different types and timing of gifts have different financial advantages or disadvantages for the donor, which is why most non-profits are at least somewhat flexible in what they will accept and how it can be used.
Endowments are not kept in savings banks. They’re invested for growth. Large endowment funds (that of Harvard University was over $34 billion at the beginning of 2008) employ many investment managers who constantly buy and sell stocks and bonds, and make other investments. If they’re well-managed, these endowments can grow by an average of 5-10% a year. (That means that some years they may not grow at all, or even shrink, and other years they may grow by much more than 10%.)
The growth of an endowment is partially determined by investment strategy, and partially by how much income is reinvested annually. Conservative funds – those that try to ensure that their funds grow safely, if slowly, despite changes in the market – typically spend about half their income and reinvest the other half.
- Planned giving arrangements. A planned giving arrangement is a way for a donor to have his cake and eat it, too – at least some of it. It allows him to contribute to a non-profit organization or institution (for, according to the government definition, charitable, educational, scientific, literary – including the arts – or religious purposes) and receive from his donation, for himself and/or another designated person or people, an income for life or for a set period. The donor gets a tax break and ongoing tax advantages, as well as a reliable income. The charity gets to invest the money, and, usually, to keep whatever’s left after all the agreed-upon payments have been made.
There are several different kinds of planned giving arrangements:
- Charitable gift annuities (CGAs). A donor’s irrevocable (non-returnable) gift to a non-profit, only part of which is a charitable donation, furnishes one or two people (usually the donor and her spouse, but it could be anyone the donor chooses) with an annuity (a fixed annual income) from the time of the gift or some agreed-upon later date until the death of the longer-lived person. The amount of the annuity is a percentage of the original donation (minus the amount recorded as a purely charitable contribution), determined actuarially by the age(s) of the beneficiary(ies) at the start of payments.
Actuarial determination. An actuary is a mathematician who works with statistics, particularly the statistics having to do with lifespan and life insurance issues. Actuaries (or people who know how to use actuarial tables), using the records of average life expectancy for men and women of different ethnicities and races in different places and at different ages, can figure out, on the average, what percentage of a gift will yield a reasonable amount for the non-profit after the beneficiary’s death. Life expectancy is based on gender, place of birth, place of residence, ethnicity, race, age, and other factors. Women, at least in the U.S., live about two years longer than men, on the average; a person born in the 1980’s has a longer life expectancy than one born in the 1940’s; your chances of living to 85 increase after you reach 65. Using these kinds of statistics, actuaries are able to develop formulas for annuity payments, life and health insurance costs, and other similar arrangements.
At the death of the last beneficiary, what’s left of the principal (some states require that it be at least 50%) goes to the non-profit. The donor and the organization sign a contract with all the details of the CGA spelled out, and the document is legally binding on both parties.
To make this a little simpler, let’s look at a fictional older couple. Gus and Tillie Brown, who met while attending State University in the 1950’s, have a great fondness for their alma mater. Life has been good to them, and the considerable amount of money they’ve made has been increased by careful investment. Gus and Tillie, who are childless, would like to share their wealth with State U., but want to make sure that they have a guaranteed income as well. They decide on a charitable gift annuity of five million dollars: one million as a direct donation to the university, and the rest to fund an annuity for them. They’ll get a tax deduction for the donation, but not for the annuity fund.
Given their ages – 72 and 74 – their payout rate of 5.8% would yield them about $230,000.00 a year. (See the table of rates recommended by the American Council on Gift Annuities.) At the death of whichever of them lives longer, whatever’s left of the original four million dollar annuity fund goes to State U. They could decide later to add to the annuity fund, which would both increase their income from it and also probably increase the amount that State U. would receive after they were gone.
- Charitable remainder trusts. With his gift, the donor sets up a trust that gives him an income for life, or for a set term. At the donor’s death or the end of the term (whichever comes first), the non-profit gets whatever is left in the trust. There are two types of charitable remainder trusts:
- Charitable remainder annuity trusts (CRATs). The trust pays the donor a set amount per year (either a specific dollar amount, or a percentage of the original value of the trust, as with a CGA). Because the payment is fixed, the trust can’t be added to.
Another possibility for Gus and Tillie would be to set up a charitable remainder trust. This could work for them in almost the same way as for a charitable gift annuity, except that they wouldn’t have to make any of the gift as a direct donation. All five million could be part of the annuity. The Browns’ payout would be a bit higher (because of the extra million dollars) if they received the same percentage of the trust’s value as with a CGA, but they couldn’t add to it later. Their tax consequences would be different from those of a CGA aswell
- Charitable remainder unitrusts (CRUTs). The trust pays the donor a fixed percentage of the trust’s fair market value each year. If the value of the trust increases in a particular year, the payment to the donor increases also; the payment decreases if the trust’s value goes down.
If Gus and Tillie expect the value of their gift to increase over time, they might choose to put their five million dollars into a charitable remainder unitrust. If the five million dollar investment increases in value by 7% a year, for instance, they’ll be collecting nearly $600,000.00 annually by the time they’re in their mid-eighties. They could add to the principal later if they chose, and, of course, in addition to either a CRAT or a CRUT, they could still choose to make a direct donation to State U.
- Charitable lead trusts. A charitable lead trust is similar to a charitable remainder trust, but works in exactly the opposite way, timewise. A donor’s gift funds a trust that makes annual payments to the non-profit for a specific term or for the donor’s lifetime, after which the balance goes to the donor or her heirs.
If Gus and Tillie wanted to leave a considerable amount to their nephew, Charlie, they might set up a charitable lead trust. This would pay State U. a specified amount for their lifetimes, making them major donors, but at the death of whichever of them lived longer, Charlie would receive whatever was left in the trust.
- Pooled income funds. A pooled income fund is essentially a mutual fund run by a non-profit. Donors contribute to the fund, and receive payments out of the interest it generates, depending on how many shares they hold (based on the size of their gift). Since their income comes only from the interest, donors receive full tax credit for the amount they invest. They can continue investing (and thus increasing their shares and income) as much as they choose to. Whatever they invest remains the property of the non-profit.
- Life insurance policies. Donors can make a non-profit the beneficiary of their life insurance policies. That gives them tax deductions on both the buy-out value of the policy (what it’s worth if they sell it back to the insurance company) and on any premium payments they make after the donation.
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