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Endowment Definition, Types and Taxation

Endowments are the lifeblood of a non-profit organisation’s (NPO) finances. And like any revenue stream, they need to be carefully managed. An endowment must be properly channelled to ensure it is properly allocated to achieving the organisation’s goals. Endowments are often much bigger than typical donations, and are essential in providing NPOs with financial stability. 

UK non-profits, including charities, educational institutions and religious organisations, typically rely less on endowments than their US counterparts. However, they are an extremely important part of their financial structure. Here we’ll look at the exact definition of an endowment and the different types of endowment, as well as their tax advantages and caveats. 

What is an endowment?

The definition of an endowment is a donation of either cash or property to an NPO that uses the income received for a specific purpose. It is a form of investment capital and needs to be channelled into the organisation’s specific goals. Sometimes the use of an endowment may be dictated by the donor as a condition of disbursement. 

Income from endowments provides NPOs with stability, allows them to make effective long-term plans, and covers administration costs and facility maintenance – the necessary expenses that are unlikely to attract the interest of casual donors. Moreover, income from endowments reduces the administrative costs of chasing pounds from casual donors over the phone, on the street or door-to-door.  

How are endowments structured?

The primary purpose of an endowment is to ensure that the principal capital (also known as the corpus) remains intact, while using investment income for essential operations. A portion of the principal will usually be disbursed slowly after a period of time has elapsed. 

This structure is the key to an endowment’s proper management as it encourages endowment fund managers to grow the income from the fund to ensure the NPO’s operational needs remain covered. The principal to income ratio may change year by year based on the prevailing market rates.

Different types of endowments

There are four main types of endowments:

  • Unrestricted endowments:. These are donations over which NPOs have complete autonomy. Assets donated may be spent, invested, distributed or saved at the total discretion of the recipient organisation.

  • Term endowments: This is where the donor stipulates that the corpus can only be extended after a period of time has elapsed or a predetermined event has occurred. 

  • Quasi-endowments: This is where an individual or institution makes a donation into a fund that is intended to serve a specific purpose. Under the conditions of these endowments, the corpus is usually retained while the earnings are used in accordance with the donor’s specifications. Quasi-endowments are usually donated by the institutions that will benefit from them. This may be by way of internal transfers or use of any unrestricted endowments that have already been gifted to the NPO. 

  • Restricted endowments:. Restricted endowments (or true endowments) typically include a written agreement stating that their principal will be held in perpetuity, and that the earnings generated from invested assets are expended in line with the donor’s predetermined specifications.

Are endowments taxed in the UK?

In the UK, as in the US, charities are tax-exempt. However, the tax laws surrounding endowments are much more regulated in the UK than they are across the pond. Endowments are not subject to tax as long as they are invested in qualifying expenditure. Non-qualifying expenditure can have tax implications for NPOs that could impede how much they are able to reinvest into themselves. Non-qualifying expenditure is anything that’s not directly related to the charity or NPO’s function. 

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If you’re interested in finding out more about endowments and money management for non-profit organisations, then get in touch with our financial experts. Find out how GoCardless can help you with ad hoc payments or recurring payments.

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