What Is A Donor-Advised Endowment Fund?

You’re interested in supporting tax-exempt charities but don’t want your money used any way they please. Suppose you want a charity to manage donations with your input and under your direction. In that case, a charitable foundation in your home community could help you achieve that goal with a donor-advised endowment fund.

A donor-advised endowment fund allows you to make charitable donations in a relatively easy and cost-effective manner while supporting the causes you are most passionate about. Because an endowment fund keeps its principal holdings, its earnings can help your charitable purpose perpetually.

Purpose Of A Donor-Advised Fund

A donor-advised endowment fund’s purpose is to manage charitable donations on your behalf. It is a simplified and immediate way to make tax-deductible charitable gifts and influence how a charity uses your gifts. Typically, the charity charges a small annual fee to each of its endowment funds to pay the charity’s operating costs. Once the endowment’s earnings cover its share of operating costs, your endowment agreement directs the foundation to use the remaining earnings for the fund’s charitable purposes.

At its core, an endowment fund is an investment fund that makes consistent distributions of some of its earnings on investments. Universities, nonprofit organizations, churches, and hospitals often use endowment funds to support charitable functions.

Public charities rely on corporate and individual donor contributions to the charities’ endowment funds. For example, many PBS television programs are funded through corporate involvement. Some prominent corporations encourage individual contributions by agreeing to match individual contributors’ gifts to endowment funds.

Favorable Tax Deductions

Donor-advised endowment funds receive favorable tax treatment because they provide essential financial support for public charities. You will immediately receive the maximum U.S. tax deduction the IRS allows and will continue to receive deductions for your additional charitable donations to the fund in the future.

Some donors can deduct up to 30% of the value of their stock or other appreciated assets from their taxable income for state and federal income tax purposes. Qualifying donors can also deduct 60% of adjusted gross income on gifts of cash.

“Qualified Charitable Distributions” are direct distributions from an IRA to a charity that offer two income tax benefits. First, the donor claims the distributions as the donor’s annual required minimum distributions. Second, the charity receives the IRA distributions tax-free.

Perhaps your wealth level is over the federal estate tax exemption limit ($11.7 million per individual in 2021, dropping to about $6 million per individual in 2026). Charitable contributions may help reduce your family’s federal estate tax burden (40% of wealth above the exemption limit) after your death.

Maintains Charitable Direction

A donor-advised endowment fund is an excellent way to protect your philanthropic interests over the long term. An endowment fund’s focused objectives allow multiple generations to continue a charitable giving legacy while preserving the original donor’s ideals and goals.

Ease Of Creation And Use

A donor-advised endowment fund can be established with any amount of money. However, most charitable foundations require endowment funds to reach minimum values before charitable beneficiaries receive endowment distributions (see “Disbursement Policy” below). Once you establish your fund, you can continue to add to it anytime, receiving tax benefits with each new gift.

Most charitable organizations offer standardized donor agreement templates to create endowment funds quickly and cost-effectively. Standardized agreements enable the organizations to operate leanly with few employees and minimal payroll costs. Although the agreement templates simplify many funds’ formations, donors must negotiate with charitable organizations for agreement customizations to match donors’ sophisticated goals. Endowment agreement negotiations take time to achieve sophisticated goals, so donors should consult legal counsel and begin negotiations as soon as possible.

A donor’s charitable gift is the donor’s only financial responsibility after establishing a fund. So, many donors make their charitable contributions after estimating their tax liability at the end of the year.

Endowment Fund Policies

Most charitable organizations’ standardized agreement templates connect to the organizations’ standardized policies on disbursements, investments, and usage through a contract law concept called “incorporation by reference.” A typical two-page endowment agreement template’s references to multiple standard policies combine those policies into the template. Incorporation by reference allows the endowment agreement to avoid “reinventing the wheel “and maintain its modest page length by recycling the policies into the agreement through the references.

Disbursement Policy

Disbursement policies often depend on the amount of money in the fund and the organization’s needs. Most endowments have an annual disbursement limit. Typically, for endowments that are meant to last in perpetuity, the percentage of disbursement is low. Most university endowments are established to last forever, and as such, have capped annual spending limits.

For example, established in 1638, Harvard University has one of the largest endowments with over $40 billion. However, in 2019, distributions from the endowment were limited to $1.9 billion because Harvard’s annual payout was capped at 5.1%. Despite having a yearly return on the Harvard endowment fund of 6.5%, the donors’ policies meant that only 5.1% could be used.

Investment Policy

An endowment fund’s investment policies govern how the fund generates distributable earnings while preserving and building the fund for the future. Most endowment fund investment policies limit the fund’s permissible risk categories. The policy guidelines also require managers to invest funds across various investment types (diversification) to minimize overall risk exposure.

As a donor, you don’t need to know all details about investment yields or rates of return. You can simply donate Funds and count on the charitable foundation’s professional managers to help achieve your charitable goals.

Usage Policy

You can govern a donor-advised endowment fund‘s use through a usage policy. This policy states the fund’s purposes and uses according to your specifications under the donor-advised endowment fund agreement.

An endowment can support general purposes:

research
teaching
public service
scholarships
fellowships
endowed chairs

An endowment can also be allocated for specific purposes:

sports program
a particular program of study
A specific type of research
a designated school at a college or university

Types Of Endowment Funds

An endowment fund can be restricted or unrestricted. An unrestricted fund gives the charitable organization free reign to use the funds to pay operating costs and serve the organization’s other purposes. Although charitable organizations need unrestricted funds to finance their daily operations, most donors establish restricted endowment funds that focus on the donors’ charitable goals.

A charitable organization holds its restricted funds’ principal in perpetuity and disperses earnings from the invested assets according to the funds’ endowment agreement restrictions.

Types Of Charitable Entities

Charitable entities operate under the laws of the states where founders have established the charities. A founder could establish an entity as a charitable trust or as a foundation. A philanthropist can create a charitable trust through the philanthropist’s last will and testament or a separate trust agreement. Alternatively, a philanthropist could file organizational documents with a state’s Secretary of State to establish a foundation as a corporation, limited liability company, or other nonprofit entity under that state’s laws.

A charitable trust or foundation can be a public or private charity. Although founders can control private charities, federal tax law limits private charity donors’ tax deductions. So, most charitable organizations that host endowment funds are public charities.

Hiring A Donor-Advised Endowment Fund Attorney

Experience and legal scholarship are essential attributes that philanthropic clients should seek in their estate planning attorneys. For almost three decades, Hawkins Elder Law has helped clients make personalized estate plans for managing their personal business and health decisions and distributing assets after their deaths. The firm’s lawyers also work year-round with their estate, trust, and elder law colleagues to study and propose improvements to the Indiana laws that affect their clients.

About the Authors

Jeff R. Hawkins and Jennifer J. Hawkins co-author this blog with Thomas E. Hynes, a lawyer admitted to practice in Pennsylvania, New Jersey and Florida who has a background in estate planning and elder law. Jeff and Jennifer are Trust & Estate Specialty Board Certified Indiana Trust & Estate Lawyers. They are also active members of the Indiana State Bar Association and the Indiana Chapter of the National Academy of Elder Law Attorneys (NAELA). Jeff is also a member of the Illinois NAELA Chapter.

Both Hawkins are admitted to practice law in Indiana, and Jeff Hawkins is admitted to practice law in Illinois.

Jeff is a Fellow of the American College of Trust and Estate Counsel and the Indiana Bar Foundation. He is also a member of the Illinois State Bar Association and he served as the 2014-15 President of the Indiana State Bar Association.

More Information

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