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What is an 'Endowment'

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

BREAKING DOWN 'Endowment'

Endowments tend to be organized as a trust, a 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 percentage of an endowment's assets are allowed to be used each year, so the amount pulled out of 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. 

  • Term endowments usually stipulate that only after a period of time or a certain event can the principal be expended.
  • Unrestricted endowments are assets that can be spent, saved, invested and distributed at the discretion of the institution receiving the gift.
  • A quasi-endowment 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 have their principal held in perpetuity, while the earnings from the invested assets are expended per the donor’s specification.

Except in a few circumstances, the terms of these 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.

Endowments and Higher Education

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, they can establish professorships, they can be awarded to students in the form of scholarships or fellowships issued for merit, or they may be 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 instance, has an endowment specifically for their botanical gardens, and Harvard University has upward of 10,000 separate endowments.

Endowment Management

The goal of any group given the task of managing a university's endowments 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. Older educational institutions like the Ivy League schools in the United States have been successful in building extremely robust funds in part because of continued donation from wealthy graduates and well managed funds.

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. For more, see Endowment Resources from the National Council of Nonprofits.

Endowment Criticism

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. A 2014 American Economic Review study looked closely at the incentives behind this behavior and found that there has been a trend toward 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 common among student activists, though the practice is evolving to improve efficacy.  

Endowments and Federally Required Payouts

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. 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.

Endowment History and Future

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

Under the U.S. tax code revamp that was passed at the end of 2017, especially large university endowments will be hit with a new excise tax of 1.4% on net investment income. While details have yet to be fully worked out, the tax could be levied on somewhere around 20 to 60 endowments serving private schools with at least 500 students and net assets of $500,000 per student even assuming moderate growth rates.

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