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Matching Foundation Payout Rates to Mission

(Aug. 15, 2005) A new report argues that foundations would be better served by matching their payout rate to the specific needs and programs of their mission as opposed to an arbitrary, government-set limit.

Under current federal law, foundations are required to distribute a minimum of 5 percent of their investment assets on grant making and other charitable activities. Money, Mission and the Payout Rate: In Search of a Strategic Approach to Foundation Spending, by Thomas Billiteri, asserts that most foundations accept this 5 percent level as the maximum amount to spend on such activities without engaging in any sort of process to see if that level is appropriate for their mission, approach and operations.

According to Billiteri, foundations need to match their payout rate to their mission by engaging their donors, board members and senior leaders in discussion about goals, the needs of grantees, fluctuating economic cycles and the unique needs of its charitable work. Some of the critical questions that need to be addressed include

  • What is the proper role of private foundations in a democratic society and in what way is that role distinct from that of charities? How has my own foundation succeeded or failed at fulfilling that role?
  • In what ways does the quality of leadership by foundation executives, trustees and donors affect the way payout policies are shaped and perceived? Are leaders at my foundation willing to step forward with a well-conceived agenda for payout, or are they simply following the herd in shaping their distribution policies?
  • Should foundations last in perpetuity? If my foundation seeks perpetuity, what is the rationale?

Foundations also need to consider whether an accelerated payout rate might be needed, perhaps because their goals are close to being accomplished or problems might be exacerbated if spending is deferred. Whatever the outcome of these discussions, answers based on strategic thinking about missions and needs are the key.

A strategic approach to mission-based payout rates would have several benefits. First, grant money would be distributed with increasing effectiveness since grant making would be tied to specific needs and programs, not on meeting an arbitrary level. Second, foundations would become more sensitive to the funding and financial challenges of grantees and probably be more willing to fund legitimate operating expenses that help fund programs in the long run. Third, foundations might find that government and donor concerns fade as payout decisions, carefully made and documented based on strategic goals, are 'explained fully in ways stakeholders and policymakers can understand.'

Policy Changes Needed Too

Billiteri notes that policy changes are needed if foundations are to be encouraged to take such a strategic-based approach to determining payout rates.

Perhaps the most prominent change would be to eliminate the current two-tiered excise tax that foundations must pay on their investment income. Foundations pay either 1 percent or 2 percent, but the policy punishes those foundations that make larger-than-usual distributions in one year by raising their tax rate over the next five years if they don't sustain their payout at the higher level. The author's solution is to implement a simple 1 percent tax on all foundations and use the funds to improve IRS oversight of nonprofit organizations, as they were originally intended (Congress traditionally appropriates the funds for other uses). AFP has supported this approach in the past.

Billliteri acknowledges that the most controversial issue is whether or not administrative expenses can be included in the payout rate. Congress has examined this issue extensively over the past several years and has considered some proposals that would eliminate all administrative expenses from the definition of 'payout rate,' leaving just charitable grants and activities. The report argues that a middle ground 'between unlimited inclusion of overhead in payout and an outright ban appears to be the best approach.' Additional research should be undertaken to identify foundations that have overhead spending in the upper, middle and lower ranges. Based on that research, benchmarks could be established as to what sort of expenses could be reasonably included in a payout rate.

About the Report

The report includes:

  • A legislative history of the foundation payout rules
  • A summary of existing research on the payout rate, including a list of key issues
  • Discussion of policy changes and their potential impact
  • Examples of foundations using a strategic-based approach

Billiteri is a former news editor at The Chronicle of Philanthropy.

Money, Mission and the Payout Rate: In Search of a Strategic Approach to Foundation Spending was distributed by the Aspen Institute's Nonprofit Sector Research Fund. The Institute is based in Washington, D.C., and is dedicated to fostering enlightened leadership and open-minded dialogue. The Nonprofit Sector Research Fund was established in 1991 to increase understanding of the nonprofit sector and philanthropy.

The paper (54 pages, PDF format) is available on the Nonprofit Sector Research Fund's website.

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