Is “Perpetual Endowment” the Best Way to Treat Large Bequests?

The following first appeared on the blog of Bloomerang, the non-profit customer relationship management software company where I work.    I appreciate the opportunity they give me to share new ideas with a broader audience.

A couple of years ago I had the opportunity to be part of an ad hoc task force at an organization with a substantial quasi-endowment, researching other endowed institutions as part of making recommendations for what we called a Financial Master Plan.

Like several other institutions in Indiana and around the country, this organization was blessed to be named in Mr. Eli Lilly’s will in 1977. Even better, the $5.1 million that this organization received in two chunks in 1977 and 1979 was unrestricted. It had no limitations on how the funds could be used. The organization could have spent it all on a bigger building, or it could have granted it to other causes. What the organization did, as have most prudent organizations for the past 60 years or so, was to treat it AS IF it was a perpetual endowment.

For almost forty years, those funds were invested it in such a way as to produce a reliable stream of income for mission – in most years, about 5%, sometimes a bit more; and sometimes, making an additional draw for a capital project or a new initiative. But the organization always reinvested enough of its earnings to maintain the original purchasing power of the principle, as a hedge against inflation. Even after those expenditures and the market crash of 2008, today those assets are worth over $20 million – when inflation would have required them to have grown to “merely” $19 million.

This organization has also seen, as have many other endowed organizations, that an endowment (or a quasi-endowment, which is what this one actually is) can become counter-productive to fundraising – both to healthy annual giving, and especially toward receiving additional planned gifts or bequests. The organization has received a few additional bequests over the years, but most of them were, frankly, token gifts – not transformational six- and seven-figure bequests that could launch new programs. Our research of ten similar-situated institutions around the country found that every one of them had faced the same challenges.

The recommendations that this task force made two years ago were put on the back burner while the organization went through a leadership transition. I imagine when the new executive is in place,  some (and probably NOT all) of them will be implemented.

Meanwhile, I’ve continued to research, write, and speak about our findings.

One member of our task force has been pointing out for years that the notion that treating a huge gift like this – or accumulated investments in general – as a perpetual endowment, the principle of which must be maintained forever, is NOT a requirement of the law, or even the ONLY way to utilize such a gift. It’s only “best practices” because the Ford Foundation said it was … less than two generations ago.

One alternative approach to using a large estate gift is to treat it not as a perpetual endowment, but as a trust – a self-liquidating asset that generates a much higher rate of return over a shorter period of time, such as one generation. I have not found many examples of non-profit organizations using this strategy; but there are a number of individual philanthropists who have used their estates this way.

Here in Indiana, the Herman Krannert Trust and the Nina Mason Pulliam Trust were set up this way. Both Krannert and Pulliam instructed their trustees to invest their estates in such a way as to spend them down gradually, over 10 to 50 years, while generating a far larger “spendable” stream of revenue than 5% in the meantime.

I’m sure many of us at some point in our lives bought enough life insurance to do this same thing – not enough to make sure our kids never had to work a day in their lives – but to last just long enough to get our kids through college. That’s what I did in 1992.

I think where this particular institution may end up is to decide to continue to treat a portion of our investments AS IF it were a perpetual endowment – enough to cover two or three core programs.

And that would free up another sum – perhaps $10 million? – to be treated as a trust that could generate twice as much usable income over twenty years – adding $450,000 to $500,000 a year in money that we could spend on new initiatives; while our annual giving supported the rest of our long-standing programs

And this has been my advice to a number of organizations, including churches of various denominations.

How do you ask someone to name you in their will in a substantial way? How do you give them guidance as to what you need? “As much as I can get” is never a good answer. For donors who want to “do perpetual good,” encourage them to make permanently-restricted endowment gifts into a fund that maintains one essential program that you will offer as long as your organization exists..

And for donors who just want to do good but not dictate their desires 100 years from now, ask them to make an estate gift sufficient to maintain their annual giving for a generation … until the next generation is able to replace it.

So, for a family that is giving $1000 a year, an estate gift of $10,000 to $12,000 would, invested as a trust instead of as a perpetual endowment, generate that same $1000 a year for 20 to 25 years – long enough for the institution to cultivate a similar family from the next generation. It would require an estate gift of twice that much to “perpetually endow” their support – if indeed the institution needs to last forever – and in the meantime, the perpetual nature of those funds could disincentivize others to give.

I’ll conclude with one real-world example. I’ve been working with a church on the west coast. This small church in a transitional neighborhood has about 60 families and an annual budget of $170,000 – enough to pay a pastor, a part-time secretary and a part-time sexton. They raise $110,000 a year in pledges, and $60,000 by renting their bigger-than-they-need parking lot to a nearby business during the week.

Last year they were approached by a non-profit organization with a proposal to sell a portion of their parking lot for the development of mixed-income housing – a proposal aligned with their mission. The offer was one million dollars. What should they do with that one million dollars?

One option would be to treat it as a perpetual endowment – in which case it would produce at best $50,000, and under current conditions maybe more like $45,000, a year. They wouldn’t be able to replace the income they were giving up.

But I shared the idea of a generational trust. Accepting this offer and investing the proceeds in an annuity that worked like a trust would mean creating a situation where they could expect perhaps $90,000 to $100,000 for eighteen to twenty years – enough to replace their lost income, and have an additional $30,000 or more per year to put toward program for two decades. And set a stake in the ground – that the two-thirds of current member households headed by people over age 55 should start  supporting their church not only with their pledges out of their income, but with a share of their accumulated wealth from their estate.

As of today, that is the course they are pursuing.

How does your organization treat large bequests? Let me know in the comments below!

About J. Ronald Newlin

Non-profit consultant, museum developer, historian, Episcopalian, blues/punk bassist
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