Foundation Payout: Considerations and Actions for Nonprofit Executive Directors

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The most visceral and contentious issue in philanthropy today is whether to increase the mandatory minimum-spending requirement—payout—that private foundations must meet.1 As the National Network of Grantmakers (NNG) put it in 1998, “Payout is the engine that drives philanthropic grantmaking and, in turn, nonprofits supported by private foundations and public charities.” However, the payout debate is largely limited to discussions among foundation directors and staff. Where is the nonprofit voice? Sometimes nonprofits are not invited; sometimes they are not interested; sometimes they are a little fearful to speak up about an issue that might put them at loggerheads with their foundation funders.

Payout ought to be one of the vital issues of the day. An increase of payout in grants of a mere one percent could increase foundation spending by $6-7 billion or more. Our nation has given foundation resources a tax exemption for the public benefit we derive from their use of resources toward meeting community needs, addressing urgent social problems, and enhancing social and economic democracy. How foundations choose to invest and spend their tax-exempt funds defines how they live up to their public benefit purposes. The payout issue addresses philanthropy writ large; it is about much more than the fates of individual foundations.

Are there reasons why nonprofit leaders are not engaged in the payout debate besides not being invited to participate? Yes; in many cases, they do not know the facts, the cutting-edge themes in the debate, and the stakes:

  • Most nonprofit executive directors and staff are unfortunately barely aware that private foundations are legally required to ‘spend’ at least five percent of their net assets each year; for many large foundations, the five percent floor seems to act as a ceiling.
  • Foundation payout typically includes grant-related administrative costs, trustee fees, other administrative expenses, and loan-like program-related investments (PRIs) in addition to actual grants.
  • The restrictions on administrative costs calculated as part of a foundation’s mandated payout were removed from the legislation long ago.
  • Many foundations don’t even make five percent, four percent or, sometimes, even three percent payout in terms of grants-only expenditures.
  • Some foundations won’t even go through the motions, opting instead to pay the penalty of a higher federal excise tax on the income from their investments rather than getting the money into the hands and budgets of nonprofits.
  • Average payout has declined over the years since the payout requirement was reduced to five percent in 1981. Overall, foundation payout in grants declined from 6.8 percent in 1984 to 4.8 percent in 1997.

Efforts to discuss increasing the required minimum foundation payout to six percent, or expanding that requirement to include public foundations and donor-advised funds, engender virulently negative reactions from some quarters. The payout topic is often shrouded in arcane legal and financial arguments, making it difficult for all but foundation insiders to consistently discuss the issue. But for every investment analyst (armed with stock market performance trends going back decades) who defends lower spending rates, you can find some other analyst willing to swear that six percent is not only justifiable but, perhaps, even too low a payout rate.

A nonprofit dependent on foundations for day-to-day survival may feel more than a little queasy at the prospect of suggesting to funders that their spending behavior is inadequate. No reasonable person will deny that there is a marked power imbalance between foundations and most nonprofits; the reality is that most foundation executives, even if they view the issue of higher foundation payment as anathema, are hardly likely to take the foolhardy step of penalizing groups engaged in a dialogue around payout. The success of any campaign elevating the payout rate is predicated on a belief that the vast majority of foundation leaders and staff want to live up to their public benefit responsibilities. Nonprofits must shed their submissive attitudes, find the courage to speak out on critical issues in philanthropy and join with foundations as partners.

It’s time for nonprofits to speak up about this vital issue; to come together as social change proponents to address the functions of foundation spending, not simply in terms of how payout affects nonprofit operating budgets, but how payout functions in our economy and society. Payout should not simply exist as the province of foundation executives, program officers, and investment advisors. Last year, the National Committee for Responsive Philanthropy (NCRP) joined the NNG’s longstanding effort to promote a foundation-spending rate of at least six percent. The potential benefits to nonprofits of increased billions of dollars in foundation grantmaking are immense. But nonprofit involvement in the payout debate must begin with understanding the issue and then finding the arenas for discussion.

  1. There is a great deal of support for increased foundation payout. Suggesting that five percent payout is too low does not turn a nonprofit into a wild-eyed radical. There is widespread sympathy for elevating the payout rate among nonprofits of varying political perspectives. At the Independent Sector national conference in November 1999, when attendees voted electronically in a town hall-type meeting on the payout question, seven-in-ten came out in favor of increasing payout. When the foundation representatives at the conference were polled, 40 percent voted in favor of increased payout. This isn’t a nonprofit versus foundation issue. Questioning the adequacy of a five percent payout, or advocating a six percent payout rate, does not relegate nonprofits to some political fringe.
  2. Payout is not simply a question about foundations; it is a question about the roles of institutions with large and growing endowments in the New Economy. Despite all the hype surrounding this nation’s bustling economy, we are still a society of ‘haves’ and ‘have-nots.’ The U.S. has the most unequal distribution of wealth in the industrialized world; a mere one percent of the population owns half the nation’s wealth. It is impossible to exempt the growing endowments of private foundations (and private universities and hospitals, for that matter) from advocacy for a redistribution of wealth. Foundations are organizations created and largely controlled by persons, families, and corporations of wealth. Bridging the wealth divide in the U.S. has to include foundation endowments in the analysis. While foundation endowments are growing, foundation payout is flagging. Getting that money out to social justice and other nonprofits must be a component of reducing the nation’s inequitable distribution and control of wealth.
  3. Foundation assets have grown enormously over the past two decades. Foundations have trotted out investment advisors such as Goldman Sachs and Cambridge Associates to defend five percent as the prudent level of spending to guard against downturns in the market and the economy. Yet, after looking at the dramatic growth of foundation assets (in recent years growing sometimes 20 percent or more a year), many analysts insist that the current economic environment warrants a different spending level. It has been a strong market for foundations’ investments, with the Dow Jones increasing from 2,400 to over 10,000 in the past ten years alone—strong enough to warrant a higher level of payout given two decades of solid asset gains. One can even take President Clinton’s off-the-cuff remark at last October’s White House Conference on Philanthropy (though directed at individual givers) to apply to foundations as well: increasing giving by one percent in light of the current market and strong economy would not hurt them, and would greatly enhance the work and impact of the nonprofit sector.
  4. Suggesting increased payout rates does not require a booming market. Stock market analysts seem to thrive on disagreement. Some insist that the stock market is undervalued; others explain that the booming stock market is due to ‘irrational exuberance.’ Many observers forget that the payout rate was only reduced to five percent to help foundations recover from the effects of the stock market downturn in the early 1970s. The subsequent decades show conclusively that foundations have rebuilt their assets, recovered nicely, and are now strong enough to return to a payout rate of six percent or more. Moreover, as Urban Institute economist Eugene Steurl has suggested, there might even be a strong rationale for increasing payout rates in ‘down markets’ as a counter-cyclical approach to America’s social and economic problems. We have to step back from irrational anxieties and undue pessimism about an impending national depression. It would take a huge, apocalyptic, and protracted market downturn to reverse the endowment growth of most foundations. The combination of pro-Wall Street economic policies and the prolonged economic boom offer little basis for anxieties.
  5. Increasing payout does not mean putting foundations out of business. The spending policies of some smaller progressive foundations have demonstrated conclusively that spending above five percent does not drive foundations into the ground—far from it! If it were true, one might ask, in which future century will X or Y foundation go out of business due to a six percent payout rate?  If it were true, the five percent spending floor would have been a legislatively mandated ceiling. The fact is, the payout requirement was not conceived by Congress to prevent foundations from paying out too much, but from paying out too little. Oddly enough, an analysis prepared for the Council on Foundations by the investment firm deMarche and Associates concluded that a hypothetical, static (one-time capitalized) foundation could have paid out as much as 6.5 percent over the past 20 years and still have seen its portfolio grow by almost 24 percent, hardly a matter of going out of business.
  6. New charitable giving, in addition to endowment growth, underlies the ability of foundations to spend more. The anticipated intergenerational transfer of wealth suggests that there is major new money coming into philanthropy; that philanthropy is not a one-time-funded environment. Even if higher payout were to dissipate foundation resources over time, the flow of new money into philanthropy will more than compensate. Barnard College economist Perry Mehrling examined the flow of capital into philanthropy to conclude that 84.5 percent of the increase in foundation assets and grantmaking capacity “has been met almost entirely by new foundation creation and gifts into existing foundations, not by reinvestment of earnings on existing assets.” The idea that we are dealing with static foundations with no living benefactors, dependent purely on the earnings on their endowments for survival, is a myth. The number of active foundations nearly doubled from 22,000 in 1980 to 40,000 in 1995, increasing to more than 44,000 by 1998, and perhaps as many as 50,000 today. Many new young philanthropists, seem to be establishing foundations and have continued income-earning potential. Philanthropy is booming; payout rates should be as well.
  7. The issue is about philanthropy’s responsibilities to today’s needs, not just tomorrow’s needs. Admittedly, over a long period, a lower payout rate results in a larger total amount of giving. However, for many nonprofits, anticipating the benefits of higher foundation grantmaking ten, fifteen, or twenty years down the pike does not address the needs of today. Moreover, in net present-value terms, more money put out now means much more than more grants a couple of decades from now. It is very hard to tell land preservation groups that there is not enough money to preserve threatened wilderness areas, but that foundation revenues for conservation will be greater in the future. Or, imagine trying to convince groups working on AIDS research about the future benefits of delayed foundation investment. There has to be a push that says to foundations: get more money out on the street now and let new and emerging philanthropists add to the charitable capital to address future social needs.
  8. Increased foundation payout can and will change the financial picture for grassroots nonprofits as well as for big, well-established nonprofits. Foundations should not be permitted to hide behind the canard that with increased spending requirements they will simply give more money to the institutions that they feel most comfortable with—big national groups, large universities, etc. An increase of payout in grants of a mere one percent could increase foundation spending by $6-7 billion or more. Excluding administrative costs, limiting payout to direct grants only (the position held by the NCRP) would result in additional billions going to the nonprofit sector. It is more than a question of ‘trickle-down,’ of more foundation spending simply resulting in a larger pool of potential grants, grassroots nonprofits can and should advocate for not only increased spending, but also for increased spending for social change. The stake for grassroots nonprofits is clear: more grants, larger grants, multi-year grants, and increased core operating support. Nonprofits can easily organize around this simple formula.

How can progressive nonprofits take on the issue of foundation payout, given all the pressures and responsibilities they face in their day-to-day work? These options are worth exploring:

  1. Join with other nonprofits locally to research and examine foundation grantmaking. Sometimes, the national information about payout is not quite as relevant as statistics on local foundation grantmaking. Identifying the top ten or twenty foundation grantmakers in a city or region and calculating their payout rates, using the foundations’ 990PF submissions, is often quite revealing and disturbing. Easy-to-follow instructions on calculating foundation payout from 990s are on the NNG’s website. Local research will also help identify those many small foundations (and the much smaller proportion of large foundations) that have increased their giving above the legal minimum. On the other hand, some foundations have claimed to have trouble merely meeting their required five percent payout because of the explosive growth of their endowments. Tracking foundations that have fallen below five percent and those whose payout in grants has cascaded downward may identify worthwhile organizing targets.
  2. Attend regional associations of grantmakers (RAG) meetings and raise questions about payout. RAG meetings are where foundations and other givers in given localities, states, or regions (often including corporate foundations and workplace fundraising federations) meet to discuss issues in philanthropy. RAG meetings are entirely appropriate forums to express concerns about payout and ask foundations about their payout track records. Many RAGs encourage stimulating and wide-ranging debates of core foundation values and may be receptive to nonprofits’ asking about payout rate philosophies. Similar meetings of state nonprofit associations and chapters of nonprofit fundraisers might also serve as venues for pointed discussion.
  3. Speak out in other public forums. Payout is an issue that should be raised in non-philanthropic forums. Human service providers, community developers, job training and placement groups, community organizers, and others should be discussing payout in their gatherings and taking positions, or adopting advocacy platforms, on payout and other issues in philanthropy.
  4. Initiate payout conversations with public policy-makers. Private philanthropy must be the hidden issue of public policy. Philanthropy now accounts for more than two percent of the U.S. gross domestic product. However, state and federal oversight of philanthropy has hardly been robust. Engaging policy-makers with responsibility for nonprofit oversight might be a first step toward generating much-needed public attention to the importance of philanthropy’s responsibility for the critical social problems of our day.
  5. Join with NNG and NCRP on their national campaign to increase payout. NNG and NCRP have been gathering support and information from nonprofits around the nation. NNG/NCRP forums and discussions educate nonprofits about the details of payout and connect them to foundations that have seen the light around increased grantmaking. We encourage nonprofits to send NNG and NCRP examples and case studies of foundations that have increased payout to serve as “yardstick competition” for the foundations still stuck at five percent. Also forward case studies of what increased foundation payout could mean for specific communities or social causes, so that the true impact of payout—getting things done to help people in need—does not get lost in the back and forth of competing stock market predictions.

In 1969, when Congress first established a mandated private foundation payout rate, the environment was strangely similar to the circumstances of the New Millennium. The economy was doing well, but many sectors of the population were trailing far behind. Foundation assets were growing, but some foundations were hardly energetic about making grants and addressing social problems. Populist members of Congress suggested raising the bar for foundations and their spending. Three decades later, pushing the legally-mandated payout rate from five percent up to six percent or greater feels like a populist issue that should be among the highest policy priorities for nonprofits interested in social justice. This is clearly a signal for all nonprofits to weigh in with their concerns about public policies related to foundations.

1. A legally-mandated payout requirement did not even exist until Congress passed the “Tax Reform Act of 1969,” which required that foundations had to spend the greater of all their investment return or six percent of net investment assets. In 1981, Congress, responding to heavy foundation lobbying, reduced the payout requirement to the current five percent level. There is no comparable requirement for “public” foundations such as community foundations.

Rick Cohen is president of the National Committee for Responsive Philanthropy, a national advocacy organization dedicated to making philanthropic institutions more accountable and accessible to the disadvantaged. Before joining NCRP, Rick was active in national, state, and local community development agencies.