What Is an Endowment?

Endowments Explained in Less Than 5 Minutes

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An endowment consists of all the donations and money a nonprofit receives specifically to generate investment income.

The principal balance usually stays invested permanently, and only the interest earned from it is used to fund programs, cover operational costs, and fulfill specific wishes outlined by the donor.

Here’s how endowments work and why organizations choose to set them up.

Definition and Examples of an Endowment

Endowments are assets a nonprofit receives to use for charitable purposes. These donations get invested in an endowment fund and the interest earned on those investments can be spent on the nonprofit’s operation.

Endowments are mostly used by large institutions, such as colleges, universities, and health care organizations. But they can also be used by religious organizations, museums, libraries, and other nonprofits.

Endowments are typically set up in the form of a trust, private foundation, or public charity.

A basic example of an endowment would be a typical donation for a university. For example, Harvard has the largest education-based endowment in the U.S. at more than $40.9 billion as of the end of 2019. It uses the investment income generated from its endowment to pay for scholarships, financial aid, and other charitable purposes.

How Does an Endowment Work?

Nonprofit organizations such as universities and hospitals use endowments to build up assets for the future. Endowments can signal to the community that the organization is stable and will have financial support for the long term.

When an endowment is first established, it typically comes with a set of guiding documents—such as a trust instrument or corporate resolution from a board of directors—that specify how the funds should be used. These documents may restrict the use of endowed funds entirely, or in some cases, may state that a portion of the principal balance can be used each year.

The amount of income available to the organization through its endowment typically depends on the size of the endowment and how it’s invested. For these reasons, some organizations hire an outside investment firm to actively manage the endowment. It may also have an entire staff or investment committee dedicated to maintaining donor relationships and increasing donations to the fund.

If an endowment gets too big, the public may wonder why the organization is hoarding funds instead of using them to meet the community’s current needs.

Types of Endowments

The IRS recognizes three main types of endowments.

True Endowment

True endowments are the most common type of endowment for colleges and universities. It’s where all the endowment donations are pooled into funds and only the interest earned on the assets is spent.

The purpose of a true endowment is to last indefinitely, so the principal amount is permanently invested and typically never gets touched.

Term Endowment

A term endowment is a pool of investments where the principal can be spent after a certain term has been met. This “term” could be that a set number of years have passed, a specific event has happened, or a growth benchmark has been reached.

Quasi-Endowment

A quasi-endowment is a pool of endowment funds where the principal can be spent as the institution’s trustees see fit.

Pros and Cons of an Endowment

Pros
  • Provides a perpetual source of funding

  • Helps an organization innovate and grow

  • Signals to the community that the organization is well established

  • Gives philanthropists a way to leave a lasting legacy

Cons
  • The organization is restricted from using the principal balance

  • The endowment loses its real value over time

  • It takes time and money to manage an endowment

  • Endowments can receive criticism

Pros Explained

  • Provides a perpetual source of funding: In most cases, an endowment’s assets stay invested forever, so the organization can use the earned interest, year over year, as a source of income.
  • Helps an organization innovate and grow: Organizations with large endowments can fund innovative research programs, recruit prestigious employees, and leverage its financial security to fuel long-term success.
  • Signals to the community that the organization is well established: Because endowments are permanent, potential donors and the community will view the organization as financially stable.
  • Gives philanthropists a way to leave a lasting legacy: Endowments are intended to last indefinitely. For individuals or families who want to leave a legacy that lasts forever, an endowment can be a great way to leave a lasting impression.

Cons Explained

  • The organization is restricted from using the principal balance: Unless it gets permission from the donor or the court, an organization can’t ever touch the principal investment.
  • The endowment loses its real value over time: If an organization spends all of the endowment’s earned interest each year, the real value of that investment will decline over time with inflation.
  • It takes time and money to manage an endowment: Organizations have to hire people to manage donor relationships and the investments.
  • Endowments can receive criticism: Some people argue that organizations would have more significant impact if they used the entire endowment donation to meet the current community needs.

Endowments by University

Some of the largest endowments in the U.S. are held by universities and colleges. As of the fiscal year 2018, educational institutions as a whole held a total of $648 billion in endowed funds.

The institutions with the largest endowments are often regarded as the most prestigious. Here’s an overview of the 10 universities with the biggest endowments, according to U.S. News & World Report’s study: 

School End of Fiscal Year 2019 Endowment
Harvard University $40.9 billion
Yale University $30.2 billion
Stanford University $27.7 billion
Princeton University $25.6 billion
Massachusetts Institute of Technology (MIT) $17.4 billion
University of Pennsylvania $14.7 billion
Texas A&M University $12.6 billion
University of Michigan—Ann Arbor $12.3 billion
University of Notre Dame $11.6 billion
Columbia University $11.0 billion

Key Takeaways

  • An endowment refers to the donations, property, and assets a nonprofit organization receives for generating investment income.
  • With most endowments, the principal balance remains invested permanently, and only the interest is used year to year to fund charitable activity.
  • Endowments are typically set up as trusts, private foundations, or public charities.
  • Endowments are usually managed by a board of trustees or directors and have documents governing when and how the funds can be used.