A spending policy is an important component of a not-for-profit’s short- and long-term financial planning. When well crafted, a spending policy can benefit an organization’s board members, donors, and overall mission by:

• Aligning expenditures with the organization’s mission and goals for longevity
• Instilling discipline when an organization is developing a budget and investing assets
• Reassuring donors that there’s a strategic plan for their contributions

Once created, a spending policy can be reviewed annually and used to help an organization determine its investment plan.

Following are requirements, parameters, and other key factors to considerations when creating your not-for-profit spending policy.

Charitable Distribution Requirements

A spending policy should allow an organization to meet its minimum charitable distribution requirements each year. In general, a private foundation is required to pay out 5% of the average market value of its noncharitable-use assets. This must be paid out by the foundation’s succeeding tax year-end.

The annual distributions depend on its average cash balances, average market value of investments, and noncharitable use assets.  

Reasonable Withdrawal Rates

It’s important to determine an appropriate, sustainable withdrawal rate from the endowment, even though this can be difficult in volatile markets. With low interest rates, income alone likely won’t be enough; the spending rate will instead need to be based on total return. That rate can be either a percentage of assets or a fixed dollar amount.

The 2017 National Association of College and University Business Officers (NACUBO)-Commonfund Study of Endowments found that a majority of organizations—endowed as well as non-endowed—compute their spending by applying their spending rate to a percentage of moving average assets.

Regulatory Parameters

To help an organization maintain not-for-profit charitable status and avoid certain excise taxes, there are several stipulations that should be outlined in the spending policy. The spending policy should prohibit political spending, self-dealing, jeopardizing investments, and the purchase of excess business holdings.

Private foundations are subject to limitations based on the percentage of their investment ownership. The limitation is aggregated with its insiders or disqualified persons. In general, a private foundation and its insiders may own up to 20% of a business enterprise. For example, a private foundation can own 15% of the voting stock of a corporation as long as its insiders don’t also own more than 5% of this voting stock. 

Optional Additional Parameters

An organization’s spending policy might also outline subsequent expenditure procedures on foreign grants or grants to other organizations that aren’t publicly supported. For example, it can address who conducts pregrant inquiry, approves grants, tracks grants, handles reporting, and more. The policy could also stipulate dollar thresholds on executive-director spending that doesn’t require board or committee approval.

The spending policy could also include compensation approval or references to a separate compensation policy. It may also note that scholarships for study or travel for employees aren’t allowed unless they strictly follow IRS pre-approved procedures.

Program and Mission-Related Investments

If your organization intends to do program-related investments (PRIs) or spending on mission investments, it should be addressed in the spending policy. It’s important to know that PRIs count toward minimum-distribution requirements and don’t jeopardize other investments.

PRIs and mission investments are treated differently, but only if the mission investment doesn’t qualify as a PRI. For example, qualifying PRIs are considered to be charitable-use assets and are excluded from the minimum-distribution calculation for the 5% payout.

On the other hand, mission-related investments that don’t qualify as PRIs are considered noncharitable use assets and are added to the computation of the 5% payout requirement.   It’s also important to note that PRIs have other due-diligence requirements, such as expenditure responsibility.

Example

Let’s say your organization has made a qualifying PRI loan to a 501(c)(4) social welfare organization to assist with construction of a building for not-for-profit organizations. The loan is for $2 million at a below-market interest rate.

In this instance, the $2 million loan receivable asset wouldn’t be included to calculate the minimum-distribution requirement. If total assets were $10 million, $2 million of which being PRI, the required distribution would be 5% of the $8 million noncharitable-use assets—amounting to approximately $400,000.

However, a mission-related investment isn’t considered a charitable use asset unless it qualifies as a PRI. That means if a private foundation had $10 million in assets, of which $2 million was a mission-related investment not qualifying as a PRI, the payout requirement would be 5% of $10 million, or $500,000.

We’re Here to Help

The rules and regulations around private-foundation spending and investing are complex and important to understand. For more information on spending policies and investment-policy statements, please contact your Moss Adams professional.