UPMIFA and Real Life: A Case Example

UPMIFA and Real Life: A Case Example

Article posted in Investing on 16 November 2011| comments
audience: National Publication, Dennis Walsh, CPA | last updated: 11 November 2016


The Uniform Prudent Management of Institutional Funds Act (UPMIFA), now enacted in 49 states, has created a new landscape for the administration of charitable endowments. In this article North Carolina CPA Dennis Walsh discusses how planned giving professionals and those advising them should be familiar with UPMIFA provisions and consider its implications when designing new gift agreements.

By Dennis Walsh, CPA

The Uniform Prudent Management of Institutional Funds Act (UPMIFA), now enacted in all states except Pennsylvania, has created a new landscape for the administration of charitable endowments. Planned giving professionals and those advising them should be familiar with UPMIFA provisions and consider its implications in the design of new gift agreements. Those charged with governance of existing endowments should recognize how the UPMIFA may affect administration of the gift instrument. And non-attorney advisers play an important role in recognizing issues that may suggest a need for review of gift agreements, as demonstrated by the case example of an actual endowment agreement presented in this article.

UPMIFA Overview

UPMIFA applies to funds that, under the terms of a gift instrument, are not wholly expendable by the institution on a current basis (i.e., “endowment funds”).  UPMIFA establishes a “prudence” standard for the management of endowments.  It enables an institution’s governing body to approve any expenditure that it deems to be prudent, including certain expenditures that would invade the corpus of an endowment fund.

UPMIFA’s prudence standard replaces its predecessor Uniform Management of Institutional Funds Act (UMIFA) “historic dollar value” standard, which prevented institutions from spending from underwater endowment funds (i.e., funds with asset values below the principal amount of the original gift, plus any subsequent contributions).

The key to UPMIFA’s flexible spending rule is the governing board’s interpretation of “prudence.”  UPMIFA identifies seven factors that must be considered in the governing board’s decision to appropriate for expenditure or accumulate endowment fund assets:

(1) The duration and preservation of the endowment fund
(2) The purposes of the institution and the endowment fund
(3) General economic conditions
(4) The possible effect of inflation or deflation
(5) The expected total return from income and the appreciation of investments
(6) Other resources of the institution
7) The investment policy of the institution

UPMIFA requires that the governing board “manage and invest the fund in good faith and with the care an ordinarily prudent person in a like position would exercise under similar circumstances.” UPMIFA also states that institutions generally are required to diversify their assets. Despite these concise provisions, UPMIFA is still young with a body of case law to be developed for guidance in applying the prudence standards. Tax exempt organization attorney Dianne Chipps Bailey has opined, "The UPMIFA prudence standards as written are sufficiently porous to leave any board with potential confusion."

The reported endowment fund balance is increased by additional contributions, investment earnings, unrealized appreciation in investment value, and is decreased by distributions and any unrealized depreciation in the value of the investments. The endowment asset is reported at its current fair market value as of the financial statement date.

UPMIFA does not override donor restrictions on the management of endowment funds. A gift agreement creating an endowment fund held by an institution may include specific restrictions on the fund’s management, thereby overriding UPMIFA’s flexible prudence standard. Similarly, UPMIFA does not relieve endowments that are classified as private foundations from complying with minimum distribution requirements under the Internal Revenue Code. However, UPMIFA permits institutions to release or modify donor restrictions on certain old and small endowment funds without first seeking donor or court approval. UPMIFA requires only that the institution seeking to release or modify such restrictions provide required notice to the state Attorney General. Other restrictions may be released with court approval.

UPMIFA also expressly permits institutions to delegate management and investment functions to professional advisors and others, provided that it uses prudence in selecting the agent, establishing the scope of the delegation, and monitoring the agent’s performance and compliance with the terms of the delegation.

Case Example

To illustrate how wording of a seemingly simple matching gift endowment can affect administration and why it is important for parties to be clear and complete in the drafting of the gift instrument, consider the following agreement, as redacted, recently adopted by a North Carolina nonprofit corporation:


This AGREEMENT is made effective on (date), between (donor) (hereinafter called DONOR) and (nonprofit), a non-profit tax exempt organization operating under the laws of the State of North Carolina with principal office located in (city) North Carolina (hereinafter called (nonprofit)).

The DONOR challenges nonprofit to raise (amount) dollars in (time period), to be matched one-for-one with a (amount) gift. Nonprofit will seek gifts restricted to an endowment fund, the earnings from which will support nonprofit operations and programs. There is no commitment of a gift to be made if the effort falls short of the (amount) goal.

Nonprofit will invest the funds received for the FUND as directed by the Board of Directors of the nonprofit. The earnings from the FUND are to enhance the operations and program costs as determined annually.

Change in Circumstances

If the purpose of the FUND designated by the AGREEMENT no longer exists, the Board of Directors (or its successor) may determine the use of the income bearing in mind the expressed desires of the DONORS and the future objectives and welfare of nonprofit. The Board of Directors shall have discretion to invade the principal only under dire circumstances to prevent failure of nonprofit.

(Signed and dated by parties)

UPMIFA applies to all new and existing charitable endowments as of the date of UPMIFA enactment, except that the UPMIFA prudence standards are subject to the intent of the donor. In the present agreement the stipulations regarding use of earnings and principal invasion would appear to apply to the donor’s matched gifts and override UPMIFA treatment with respect to matched gifts.

But what about gifts to the endowment received from other donors?  Are these gifts subject to the stipulations as well or to be separately administered pursuant to the UPMIFA prudence standards? If gifts other than matched gifts are not subject to these restrictions, it is reasonable to ask if spending, earnings, and changes in capital value must therefore be bifurcated and traced as attributable to UPMIFA versus non-UPMIFA governed funds.

The donor made an explicit stipulation that principal be invaded only in the event of dire circumstances that would result in failure of the organization. However, this provision is not accompanied by any guidance as to what constitutes “principal” or “dire circumstances.” Surely, various governing bodies can look at the same situation and reasonably conclude differently as to what circumstances threaten sustainability of the organization. Where stipulations are found to be vague and open to interpretation, corrective action should be taken to clarify donor intent.

Similarly, the gift agreement is silent on the definition of “income” and “earnings.”  Clearly, any interest or dividends received from investments fall within the traditional definition of trust accounting income. But what about capital appreciation, such as realized gains from the disposition of securities? Would the donor prefer that the board have the power to decide whether to make this available for spending as circumstances change over time as well as to have the option to reinvest all or a portion of such return from year-to-year to help preserve the inflation-adjusted purchasing power of the endowment?

The agreement does not call for the segregation of funds either in separate accounts or with an independent trustee. Where endowed assets are permitted to be blended with other corporate assets it can be very difficult to enforce donor stipulations. In some cases, such an endowment may need to be established as a trust to assure donor objectives are met. This may enhance the likelihood of the donor’s charitable intent being carried out in perpetuity. 

Alternatively, if endowed funds remain in corporation title and without modification to the gift agreement, the board may choose to follow the most conservative interpretation of the gift instrument by limiting spending to interest and dividends earned on the endowed funds as a whole (i.e. from both matched and other gifts), and then only to the extent the total capital asset value of the endowment is greater than cumulative contributions (i.e. as under the pre-UPMIFA historic dollar value standard).

But the donor’s intent may be better served by permitting prudent spending from capital gains in addition to interest and dividends. Moreover, the donor may not want to see the organization cut off from endowment funding during periods of volatility in the financial markets when the current investment value of the fund may be temporarily below the original value of the gifts.

Further, where expendable income is defined under traditional trust accounting rules, the character of portfolio return may serve to constrict the scope of investment choices available as the organization seeks to balance the need for risk-adjusted investment return with its ability to appropriate such return. Over time the investment markets will alternately favor assets emphasizing income (i.e. interest and dividends) versus assets that yield little if any current income but may produce higher return through capital appreciation.

UPMIFA facilitates modern portfolio theory by not calling for such a distinction between income and capital appreciation in the decision to spend or accumulate funds. As a result, under UPMIFA and consistent with a total return concept of investing, preference for investment assets yielding interest and dividends should not be a primary driver in the design of the investment portfolio as might be the case where income is defined under traditional trust standards.

Total return investing also facilitates the use of a spending rate as a tool of management prudence. Where funds are governed under traditional trust accounting rules and the governing body sets a spending rate, say 4%, but realized investment return is less than this rate, endowment distributions are limited to the lesser realized earnings along with any undistributed earnings accumulated from earlier years, but only to the extent this does not result in the endowment principal going underwater. By contrast, if governed under UPMIFA the organization has the potential to make endowment distributions based on such an established spending rate, subject to the prudence standards, even in situations that may result in the invasion of principal.

Under the guidance of legal counsel, the board might reach out to the donor to consider these issues and develop alternatives for restructuring the gift arrangement in a manner that results in a more complete documentation of donor intent and that sets forth the obligations of the charity. The parties may wish to amend the gift instrument to specify that it be wholly governed under UPMIFA or in the alternative to create a trust and place the endowed funds with an independent trustee. This will serve both the donor and nonprofit by providing clarity with respect to donor intent and applicable governing law.

* * * * *

About the Author

Through The Micah Project, Dennis Walsh, CPA serves as a volunteer consultant to religious workers and exempt organizations, focusing on financial management, legal compliance, and organizational development. A graduate of the University of Wisconsin, he completed the Duke University certificate program in nonprofit management and is a member of the North Carolina Association of CPAs and the American Institute of CPAs.

Dennis is the author of “Legal & Tax Issues for North Carolina Nonprofits” and has written for various nonprofit publications. He actively volunteers with the Guilford Nonprofit Consortium, the Not-for-Profit Committee of the NCACPA, and for the accounting assistance program of the North Carolina Center for Nonprofits.

Mr. Walsh can be reached at nonprofitcpa365@gmail.com.

The author wishes to thank Suffolk University law professor Charles Rounds, Jr. and Michael R. Abel, J.D. of Schell Bray Aycock Abel & Livingston PLLC, Greensboro, NC for their review of this article, and attorney Dianne Chipps Bailey of Robinson Bradshaw & Hinson PA, Charlotte, NC for permission to draw from “North Carolina Adopts New, Flexible Approach to Endowment Spending,” 2009.

Helpful References

From UPMIFA Section 4(a)  Appropriation for expenditure or accumulation of endowment fund; rules of construction.

(a) Subject to the intent of a donor expressed in the gift instrument, an institution may appropriate for expenditure or accumulate so much of an endowment fund as the institution determines is prudent for the uses, benefits, purposes, and duration for which the endowment fund is established. Unless stated otherwise in the gift instrument, the assets in an endowment fund are donor restricted assets until appropriated for expenditure by the institution. In making a determination to appropriate or accumulate, the institution shall act in good faith, with the care that an ordinarily prudent person in a like position would exercise under similar circumstances, and shall consider, if relevant, the following factors:

(1) The duration and preservation of the endowment fund;
(2) The purposes of the institution and the endowment fund;
(3) General economic conditions;
(4) The possible effect of inflation or deflation;
(5) The expected total return from income and the appreciation of investments;
(6) Other resources of the institution; and
(7) The investment policy of the institution.

Accounting standard excerpts:

• The Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) glossary defines a donor-restricted endowment fund as an endowment fund that is created by a donor stipulation requiring investment of the gift in perpetuity or for a specified term.  Some donors may require that a portion of income, gains, or both be added to the gift and invested subject to similar restrictions.

• FASB ASC  958-205-45-14  states  that  when  classifying an  endowment fund,  each source—original  gift,  gains and  losses,  and  interest  and  dividends—must  be  evaluated  separately.  Each  source  is   unrestricted  unless its  use  is  temporarily or permanently  restricted  by  explicit donor  stipulations  or by  law.

• To the extent that they are recognized, FASB ASC 958-32-45-1 requires that investment gains and losses should be reported in the statement of activities as increases or decreases in unrestricted net assets unless their use is temporarily or permanently restricted by explicit donor stipulations or by law.

• Section 8.28  of the AICPA Not for Profit (NFP) Audit and Accounting Guide states that in  the  absence  of  donor  stipulations  or  law  to  the  contrary,  losses  on  the investments of  a  donor-restricted  endowment fund  shall  reduce  temporarily  restricted  net  assets  to  the  extent  that  donor-imposed  temporary  restrictions  on  net  appreciation  of  the  fund  have  not  been met  before  a  loss  occurs.  Any remaining loss shall reduce unrestricted net assets.

• Section 8.27 of the Guide points out that In  a  state  that  has  Enacted  a  version  of  UPMIFA,  legal  Limitations  may  state  that,  "unless  stated  otherwise in  the  gift  instrument, the  assets  in  an  endowment  fund  are  donor-restricted  assets  until  appropriated  for  expenditure by the institution. 

• Paragraph  8  of  FASB Staff Position (FSP) 117-1, which sets forth guidance on the effect of UPMIFA on the application of Financial Accounting Standard (FAS) 117, Financial Statements of Not for Profit Organizations,  states  that  for  each  donor-restricted  endowment  fund  for  which  the  restriction  described  in   subsection 4(a)  of  UPMIFA  is  applicable,  an  NFP  shall  classify  the  portion  of  the   fund that  is  not  classified  as  permanently  restricted  net  assets  as  temporarily  restricted  net  assets (time restricted)  until   appropriated  for  expenditure  by  the  NFP.

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