What Is an Endowment?

An endowment is a donation of money or property to a nonprofit organization, which uses the resulting investment income for a specific purpose. An endowment can also refer to the total of a nonprofit institution's investable assets, also known as its principal or corpus, which is meant to be used for operations or programs that are consistent with the wishes of the donor(s). Most endowments are designed to keep the principal amount intact while using the investment income for charitable efforts.

Key Takeaways

  • Most endowments are designed to keep the principal amount intact while using the investment income for charitable efforts.
  • Endowments tend to be organized as a trust, a private foundation, or a public charity.
  • Educational institutions, cultural institutions, and service-oriented organizations typically administer endowments.

Understanding Endowments

Endowments are typically organized as a trust, private foundation, or a public charity. Many endowments are administered by educational institutions, such as colleges and universities. Others are overseen by cultural institutions, such as art museums or libraries, religious organizations, and service-oriented organizations, such as retirement homes or hospitals.

In some cases, a certain percent of an endowment's assets are allowed to be used each year so the amount withdrawn from the endowment could be a combination of interest income and principal. The ratio of principal to income would change year to year based on prevailing market rates.

Endowment Types

There are four different types of endowments: unrestricted, term, quasi, and restricted:

  • Unrestricted endowments. These are assets that can be spent, saved, invested and distributed at the discretion of the institution receiving the gift.
  • Term endowments. This setup usually stipulates that only after a period of time or a certain event can the principal be expended.
  • A quasi-endowment. This is a donation by an individual or institution, given with the intent of having that fund serve a specific purpose. The principal is typically retained while the earnings are expended or distributed per specifications of the donor. These endowments are usually started by the institutions that benefit from them via internal transfers or by using unrestricted endowments already given to the institution.
  • Restricted endowments. These have their principal held in perpetuity, while the earnings from the invested assets are expended per the donor’s specifications.

Except in a few circumstances, the terms of endowments cannot be violated. If an institution is near bankruptcy or has declared it but still has assets in endowments, a court can issue a doctrine of cy-près so the institution can use those assets toward better financial health while still honoring the wishes of the donor as closely as possible. 

Drawing down the corpus of the endowment to pay debts or operating expenses is known as invading, or endowment invasion, and sometimes requires state approval.

Requirements for Endowments

Managers of endowments have to deal with the push and pull of interests to make use of assets to forward their causes or to sustainably grow their respective foundation, institution, or university. The goal of any group given the task of managing a university's endowments, for example, is to sustainably grow the funds by reinvestment of the endowment’s earnings while also contributing to the operating cost of the institution and its goals. 

Management of an endowment is a discipline unto itself. An outline of considerations compiled by a leading management team includes: setting objectives, developing a payout policy, building an asset allocation policy, selecting managers, managing risks systematically, cutting costs, and defining responsibilities. 

Philanthropies, or more specifically private non-operating foundations, a category that includes the majority of grant-making foundations, are required by federal law to pay out 5% of their investment assets on their endowments every year for charitable purposes. Private operating foundations must pay substantially all—85% or more—of their investment income, while community foundations have no requirement. 

Under the Tax Cuts and Jobs Act of 2017 and the Bipartisan Budget Act of 2018, substantially large university endowments must pay a tax of 1.4% on net investment income. This tax is levied on endowments held by approximately 35 private colleges and universities with at least 500 students and net assets of $500,000 per student.

Endowments and Higher Education

Older educational institutions, such as the Ivy League schools in the United States, have been successful in building extremely robust endowment funds in part because of the continued donation from wealthy graduates and well-managed funds.

Endowments are such an integral part of Western academic institutions that the size of a school's endowment can be a fair measure of its well-being. They provide colleges and universities with the ability to fund their operating costs with sources other than tuition and ensure a level of stability by using them as a potential rainy-day fund.

Endowments set up by these institutions or given as gifts by donors have multiple uses. They can ensure the financial health of specific departments, establish professorships; zbe awarded to students in the form of scholarships or fellowships issued for merit, or used as assistance to students from a background of economic hardship.

Chair positions or endowed professorships are paid with the revenue from an endowment and free up capital that institutions can use to hire more faculty, increasing professor-to-student ratios. These chair positions are considered prestigious and are reserved for senior faculty. Endowments can also be established for specific disciplines, departments or programs within universities. Smith College, for example, has an endowment specifically for its botanical gardens, and Harvard University has 13,000 separate endowment funds. 

Marcus Aurelius established the first recorded endowment for the major schools of philosophy in Athens circa 176 AD.

Criticism of Endowments

Harvard and other elite higher educational institutions have come under criticism for the size of their endowments. Critics have questioned the utility of large, multi-billion-dollar endowments, likening it to hoarding, especially as tuition costs began rising at the end of the 20th century. Large endowments had been thought of as rainy-day funds for educational institutions, but during the 2008 recession, many endowments cut their payouts. An American Economic Review study looked closely at the incentives behind this behavior and found a trend toward an overemphasis on the health of an endowment rather than the institution as a whole. 

It's not unusual for student activists to look with a critical eye at where their colleges and universities invest their endowments. In 1977, Hampshire College divested from South African investments in protest of apartheid, a move that a large number of educational institutions in the United States followed. Advocating for divestment from industries and countries that students find morally compromised is still prevalent among student activists, though the practice is evolving to improve efficacy. 

More recently, several Ivy League universities in the U.S. with multi-billion-dollar endowments declined to accept millions they were set to receive as part of a $14 billion federal aid package for higher education included in the CARES (Coronavirus Aid, Relief, and Economic Security) Act.

After receiving backlash, Harvard University announced in April of 2020 that it would not accept $8.6 million that it it had been designated. Princeton University and Stanford University also said they would not accept millions in funds they had been allocated via the CARES Act. 

Real World Examples of Endowments

The oldest endowments still active today were established by King Henry VIII and his relatives. His grandmother, Countess of Richmond, established endowed chairs in divinity at both Oxford and Cambridge, while Henry VIII established professorships in a variety of disciplines at Oxford and Cambridge. 

Harvard has the largest university endowment in the world. It totaled $40.9 billion in June 2019, the end of its fiscal year. The University of Texas has the second largest endowment in the U.S. with $31 billion is assets. 

Harvard officials have said that like other universities, due to the impact the coronavirus crisis has had on the economy and financial markets, its endowment has suffered major investment losses in 2020. 

According to U.S. News & World Report, the top five universities by endowment size at the end of the fiscal year 2018 were:

  1. Harvard University $39,233,736,000
  2. Yale University $29,444,936,000
  3. Stanford University $26,464,912,000
  4. Princeton University $25,438,300,000
  5. Massachusetts Institute of Technology (MIT) $16,400,027,000