Spend-Down Policies Offer Flexibility
March 20, 2017
Perpetuity is no longer the default position for philanthropists establishing a private nonoperating foundation or donor-advised fund (DAF) in the US. But not all philanthropists understand the profound implications for asset allocation that come from choosing to spend down their assets rather than aim for perpetuity: Spend-down policies generally offer much greater flexibility.
A not-for-profit’s spending policy should align with its philanthropic mission. If your goal is earthquake reconstruction, for example, you may want to spend down your foundation’s or DAF’s assets rapidly. For other goals, you might prefer to maximize how long the distributions last—or maximize the stability of distributions. If a spend-down policy suits your organizations goals, there are advantages—and trade-offs—to consider.
Foundations aiming for perpetuity require a high allocation to return-seeking assets such as stocks (typically 70% or more) to generate the growth needed to sustain their legally required 5% annual distributions and stay ahead of inflation, which will likely result in greater volatility in both annual returns and distributions than the trustees desire. Typically, the investment policies that lead to longevity and stability of distributions tend to be at odds. In contrast, foundations and DAFs that plan to spend down their assets have greater flexibility about their investment policies and can take steps to stabilize distributions, if that would serve their charitable goals.
As the Display below shows, we estimate that a $10 million perpetual foundation with a 5% annual spending policy and a 70% stock allocation would have significantly more total philanthropic value (TPV) after 20 years than a foundation with the same asset allocation that is spending down its assets. (TPV is an inflation-adjusted measure of financial impact that sums distributions over time with any remaining assets that will support future giving.) However, the foundation spending down its assets faces less risk of distributions falling 5% from one year to the next.
The foundation spending down its assets could stabilize distributions even further, if it’s willing to give up some TPV. Reducing the stock allocation to 50% would lower the odds of a 5% year-over-year drop in distributions from 19% to 14%, but also reduce TPV from $14.4 million to $13.2 million. That option generally isn’t available to a perpetual foundation, which needs the growth that a higher stock allocation can generate over time.
The foundation spending down its assets could also adopt a rule that it will never spend less from one year to the next, with minimal impact on its TPV, whether it allocated 70% or 50% of its assets to stocks. (The slight odds of a 5% decline in annual distributions shown capture the final year, when only a little capital may be left.) If you think a drop in annual funding would be highly disruptive to the programs you support, you can reduce that risk—but it may mean granting less money over time.
The Bernstein Wealth Forecasting System seeks to help investors make prudent decisions by estimating the long-term results of potential strategies. It uses the Bernstein Capital Markets Engine to simulate 10,000 plausible paths of return for various combinations of portfolios, and for taxable accounts, it takes the investor’s tax rate into consideration.