Managing Charitable Dollars

5.  Charitable Investments – Knowing the Law

If your nonprofit has an endowment (either a Board-designated endowment or a true, traditional endowment) or a reserve fund, the Board needs to adopt an investment policy statement (IPS) to guide investment and spending decisions.

To develop an IPS, the Board needs to understand the legal requirements for investing and spending charitable funds and define the organization’s values and desired impact. Below we summarize the legal requirements for managing a nonprofit’s dollars, and in Topic #6 we provide tools to help define your organization’s values and write an IPS that reflects them.

Laws for Managing Charitable Dollars

The laws governing charitable organizations talk about principal and income, which generally means the investing and spending decisions by the Board. In plain language, investing means decisions to preserve and grow the nonprofit’s assets – or its principal such as reserve funds and endowments – for the long-term. While spending generally means giving the funds – or the income from the investments – away to grantees or spending the income on the nonprofit’s annual programs and operational expenses.

In general, the laws require a Board to exercise prudence in making both investment and spending decisions for the nonprofit. In Pennsylvania, one way a Board exercises prudence is to follow a total return investment policy.  They do this by electing – in writing – to follow the Pennsylvania statute and to spend (and treat as income) between 2% and 7% annually on grants, programs, and operations, and to invest the rest of the charitable assets prudently. For more information download our Summary of Pennsylvania’s Laws for the Investment and Spending of Charitable Funds.  Or see our Sample Board Resolution Making an Income Election.

Federal laws for private foundations apply a similar standard of prudence requiring Boards to exercise “ordinary business care and prudence” when making an investment or run the risk of having an excise tax imposed if the investment is deemed a “jeopardizing investment”. Additionally, private foundations are required to pay out 5% annually for grants, programs, and operations, which may be thought of as a minimum spending rule. For more information download our Summary of the Private Foundation Rules regarding Investment and Spending.

Legal Authority Related to Impact Investing

For charitable organizations interested in impact investing, Treasury Notice 2015-62 provides that market rate returns are not required when organizations make impact investments in furtherance of their mission. This is important because the Notice clarifies that Boards are not required to select only investments that offer the highest rates of return, the lowest risks, or the greatest liquidity. Rather, they may consider all relevant facts and circumstances of a mission-related investment (MRI) including the relationship between a particular investment and the organization’s charitable purposes, making MRIs a valuable tool to drive impact. An example of this might be for a nonprofit dedicated to creating affordable housing to make a below-market loan to finance a new affordable housing project.

Similarly, the private foundation rules provide a specific exemption from the jeopardizing investment rules (and other private foundation rules) for program-related investments (PRIs) that are made primarily for a charitable purpose or in furtherance of the organization’s charitable mission. And, importantly, PRIs that are structured in accordance with the statutory requirements can qualify for the annual 5% pay-out, which makes them a valuable tool for organizations seeking to increase their impact.

With this legal background, Topic #6 has tools and resources for defining an organization’s values and writing and adopting an investment policy statement to manage and make the most of the organization’s charitable dollars.