What Is a Spending Policy for a Foundation or Endowment?

The Short Answer

A spending policy is a formal rule that determines how much a foundation or endowment distributes each year to support its mission and operations. Most policies aim to balance two goals: providing meaningful, predictable support today and preserving the purchasing power of the assets for future beneficiaries, often described as intergenerational equity. Common approaches apply a percentage, often in the range of 4% to 5%, to a smoothed average of asset values over several years. Private foundations must also meet a federal minimum distribution requirement of generally 5% of net investment assets.

Why Does a Spending Policy Matter?

A clear spending policy creates discipline and predictability. It helps budget planning, reduces pressure to change distributions in reaction to short-term market movements, and links investment strategy to the organization’s mission. Without one, spending decisions may become inconsistent, potentially drawing down assets in strong markets or cutting support abruptly in weak ones.

The spending rate and the investment strategy are closely connected. To preserve purchasing power over time, a portfolio generally needs to earn at least the spending rate plus inflation plus investment and administrative costs.

What Are Common Spending Policy Approaches?

Simple Percentage of Assets

The organization distributes a fixed percentage of the current market value each year. This is easy to understand but can lead to volatile distributions as markets fluctuate.

Moving Average (Smoothed) Approach

The most common approach applies a fixed percentage to an average of asset values over a trailing period, often 12 to 20 quarters. Smoothing reduces year-to-year volatility in distributions while still allowing spending to respond to longer-term market trends.

Inflation-Adjusted Spending

The prior year’s spending is increased by inflation, sometimes within upper and lower bounds tied to asset values. This provides predictable growth in support but may not respond quickly to significant market changes.

Hybrid Approaches

Some institutions blend an inflation-adjusted amount with a percentage of a smoothed asset value. This approach seeks to combine stability with responsiveness.

What Rules Apply?

Private foundations are generally required to make qualifying distributions of at least 5% of the average market value of their net investment assets each year. Qualifying distributions include grants and reasonable administrative expenses related to charitable activities. Falling short can result in excise taxes.

Endowments of public charities are typically governed by state law. Most states have adopted the Uniform Prudent Management of Institutional Funds Act (UPMIFA), which requires that spending decisions consider factors such as the duration and preservation of the fund, the purposes of the institution and the fund, general economic conditions, the possible effect of inflation or deflation, expected total return, other resources of the institution, and its investment policy. Donor restrictions and gift agreements also govern how specific funds may be spent.

How Should a Spending Rate Be Set?

Setting the rate involves weighing current mission needs against long-term sustainability. Questions to consider include the organization’s time horizon, whether it intends to exist in perpetuity, its reliance on the fund for operating support, its expected investment returns, and the potential for new contributions. A spend-down foundation with a defined lifespan will approach the question very differently than a perpetual endowment.

How Often Should the Policy Be Reviewed?

The spending policy should be reviewed periodically, often annually alongside the investment policy statement, and whenever the organization’s mission, funding needs, or capital market expectations change materially. Our resource on what a nonprofit investment policy statement should include explains how the two documents work together.

The Takeaway

A thoughtful spending policy aligns an organization’s investment strategy with its mission, supporting today’s work while preserving resources for the future. Clear rules, sound governance, and periodic review help foundations and endowments navigate changing markets with confidence. Learn more about Newport’s work with foundations and endowments, including investment and spending policy development and outsourced CIO (OCIO) services.

This article is provided for educational purposes only and is not individualized investment, tax, or legal advice. Please consult qualified professionals about your specific circumstances and review our disclosures.