Guest contributors Sarah Bothma and Ed Russell from Underberg & Kessler, LLP share the ways donors can benefit from creating an endowment.
An endowment provides great flexibility for charitable giving, allowing a donor or donors to control the class of recipients eligible for grants and which charitable purposes to support. While most people might associate endowments with specific charitable organizations, free-standing and unaffiliated endowments can also be created. Endowments are ideal mechanisms for charitable giving by individuals, families, or businesses desiring to have a lasting charitable impact.
The first step in forming an endowment is identifying the donor’s charitable purpose. This largely determines how to define and structure the endowment. For example, a donor may wish to establish an agency fund, in conjunction with a particular organization, for the purpose of providing targeted financial support to something like a fund for a local library.
If the donor wants to provide support to more than one charitable organization, then they should establish a designated funds endowment. This type of endowment allows the donor to specify certain nonprofit organizations for gift giving. For donors who desire a broader charitable giving approach, a ‘field of interest’ fund endowment makes grants to organizations operating in the field of interest identified by the donor, such as the arts or education.
An endowment is not a legal entity, but instead refers to an arrangement whereby assets are invested, managed, and disbursed for the donor’s specified purpose. Endowments are usually organized as a not-for-profit corporation or a trust, which obtain tax-exempt status as a private foundation or public charity. The benefit of obtaining such tax-exempt status is that the fund can grow in a tax free, or tax-advantageous, manner. This allows it to make a long-lasting impact. Tax-exempt status also permits donors to take current tax deductions for assets used to create the fund, even if it does not start making charitable gifts until a later time.
Public charity status requires the organization receive a majority of its funding from the public; however, the deductions available to individuals and corporations from donations to public charities are subject to a higher limit than deductions to private foundations.
Even though public charities have a higher deductibility than private foundations, most endowments which are not affiliated with an existing public charity are formed as private foundations. The benefit of a private foundation is control. Related parties may control the endowment, and private foundations can be funded by fewer individuals, or even one person.
An endowment doesn’t require a large investment right away
It is common for donors to establish an endowment with a modest investment and add additional assets over time as part of retirement and estate plans. Funding an endowment as part of a retirement or estate plan can also be tax advantageous. Donors who do not need their full IRA required minimum distribution (“RMD”) during retirement or who will be bumped into a higher federal income tax bracket by taking their full RMD can use an IRA charitable rollover, as long as the endowment is not a donor advised fund. The endowment can also be designated a beneficiary of the donor’s estate or their retirement accounts, which can also reduce taxes.
Rochester is currently a good environment for creating an endowment. Take Mackenzie Scott’s recent giving of $20 million to the United Way of Greater Rochester, which was part of the $4.2 billion she gave to charities and endowments around the country. But, as discussed, creating an endowment is not reserved for billionaires.
If your organization does not currently have an endowment, now may be the time to start thinking about forming one. To learn more, watch our on-demand webinar where leaders in our non-profit community share their experiences in creating an endowment fund.
Manning & Napier is not affiliated with Underberg & Kessler, LLP. The information in this article is not intended as legal or tax advice. Consult with an attorney or a tax or financial advisor regarding your specific legal, tax, estate planning, or financial situation.