What Higher Foundation Payout Rules Would Mean for Charities

The 5% minimum distribution rule for private foundations effectively balances immediate charitable giving with long-term sustainability.

Critics propose raising the payout rate to 10%, or even 12%, but model forecast simulations show this would harm long-term giving capacity.

A 12% payout rule would significantly deplete foundation assets, leading to less overall charitable support in the long-term. Specifically, foundation grantmaking capacity after thirty years under 12% payout rules is reduced to about one-fifth of grants made under a 5% annual distribution.

Charities, which depend on this consistent long-term support, would struggle to cover their basic operating expenses if foundation assets were depleted.

The current 5% rule effectively balances short-term impact with long-term support for crucial societal needs. Proposals to raise the payout rate would significantly stifle the long-term grantmaking capacity of foundations.

Striking a Balance for Long-Term Charitable Support

The United States boasts a vibrant philanthropic landscape, with approximately 125,000 private foundations collectively contributing over $100 billion to charitable causes annually. These foundations play a crucial role in supporting a wide range of social and environmental initiatives, fostering innovation, and addressing pressing societal challenges.

Since the enactment of the Tax Reform Act of 1969, private foundations have been subject to stringent rules and regulation by the Internal Revenue Service (IRS). One of the cornerstones of this regulatory structure is the 5% minimum distribution rule.¹ This rule mandates that private foundations distribute at least 5% of the fair market value of their assets each year to qualified charitable organizations. This requirement serves a dual purpose: it ensures that foundations make a meaningful contribution to charitable causes in the near term while also allowing them to maintain long-term support for their chosen beneficiaries.

The establishment of the 5% minimum distribution rule reflects a carefully considered balance between two competing interests. On one hand, it is essential that private foundations utilize their resources effectively to address pressing societal needs. On the other hand, foundations should have the flexibility to plan for the future and provide sustained support to their chosen charitable causes. The 5% minimum distribution rule has proven to be an effective mechanism in striking this balance. Charitable giving statistics demonstrate foundation giving is making up a growing share of total charitable giving over time. In 2000, foundation giving made up 11% of total charitable donations. By 2010 this had risen to 14%, and by 2022 it was 21%.² This trend highlights the growing dependence of charitable organizations on foundation grantmaking, while the shift in giving trends highlights the need for flexibility in catering to diverse donor preferences.

Offering the choice between focusing resources on immediate needs, like workforce development, and establishing a longer-term strategy empowers foundations to cater to various philanthropic motivations. This freedom ensures donors tackling pressing issues like global poverty, which require sustained efforts, can plan strategically. Those seeking immediate impact can allocate funds toward initiatives like workforce development, addressing short-term needs effectively.

One of the advantages of foundations choosing to use long-term giving plans is they can move out vastly more money to charitable causes than they could have done with their initial endowment alone. For example, Henry Ford left his foundation the equivalent of about $4 billion.³ Adjusted for inflation, the Ford Foundation has granted well in excess of $50 billion over the decades, granting more than $7 billion in charitable disbursements in the past decade alone.⁴ The long-term giving strategy of the Ford Foundation has resulted in significantly more funds flowing to charities than a time-limited endowment spend-down could ever achieve.

Calls to Raise the Payout Rate Requirement

While the 5% benchmark strikes a balance between resource allocation for charitable activities today and long-term asset growth and stability, the 5% rule does have its critics. A common criticism largely stems from concerns about concentrated wealth and the perception that foundations are not sufficiently distributing funds to charitable organizations.⁵

For instance, the progressive Institute for Policy Studies (IPS) says wealthy individuals primarily utilize private foundations as tax-mitigation tools rather than vehicles for direct philanthropic impact. To address this alleged problem, critics have suggested raising the payout requirement to 10% and applying a 2% wealth tax to private foundation funds. In other words, a 12% payout requirement for foundations with assets over $50 million.⁶

What This Would Mean for Long-Term Grantmaking

Given that the existing payout rules were carefully chosen to strike a delicate balance between charitable contributions and reliable long-term giving, a 12% payout requirement would likely lead to fewer charitable dollars reaching charities as foundation assets would be rapidly diminished. To demonstrate how such a proposal would impact the long-term giving capacity of a large foundation, this report conducts a forecast simulation model using the Ford Foundation as an example of a major funder of payout rate critic IPS. As of the latest available tax filing data, the Ford Foundation has $20 billion in foundation assets ($20.07 billion fair market value).⁷

To apply an asset portfolio balance that closely aligns with how most foundations allocate investments, we replicate the 35% fixed income model portfolio used by the Council on Michigan Foundations in their 2020 report.⁸

In estimating forecast returns for fixed income, U.S. equities, and international equities, we use Vanguard’s Capital Markets Model (VCMM).⁹ With investment allocations and forecast returns determined, we run a Monte Carlo Simulation model over a 50-year period applied to the current assets of the Ford Foundation.10 The model compares the same simulation model with one difference: one model demonstrates the median grantmaking capacity of the foundation subject to the current 5% payout rule; the other demonstrates the median grantmaking capacity of the foundation subject to a 12% payout requirement.

In estimating forecast returns for fixed income, U.S. equities, and international equities, we use Vanguard’s Capital Markets Model (VCMM).¹⁰ With investment allocations and forecast returns determined, we run a Monte Carlo simulation model over a 50-year period applied to the current assets of the Ford Foundation.¹¹ The model compares the same simulation model with one difference: one model demonstrates the median grantmaking capacity of the foundation subject to the current 5% payout rule; the other demonstrates the median grantmaking capacity of the foundation subject to a 12% payout requirement.

Figure 1 below shows how the median grantmaking capacity of a large foundation differs significantly when applying a 5% versus a 2% payout requirement. While a foundation subject to a 5% payout rule—out in larger grants to charity in the first ten years of the simulation—about 45% more in the following forty years, a foundation subject to the 5% payout rules 222 percent more grants to charity. The forecast simulation also shows, under the 5% payout rules, charities receive a long-term line of support from the foundation.

Conversely, under 12% rule, charities have a windfall of large grants for only a few years, and then the funds quickly dry up as the foundation’s assets are depleted. After twenty years, a foundation subject to the 5% payout rule out more than double the foundation subject to 12% payout requirements. After thirty years this gap in grantmaking capacity has grown to almost five-fold. By the end of the fifty-year simulation period, a foundation consistently paying out 5% would be granting $840 million more to charity than a foundation paying out 12%. Over the entire fifty-year, a twenty-two-fold difference. Over the entire fifty-year period, a foundation operating under the 5% rule would have donated almost $21 billion more to charity than a foundation operating under 12% payout rules.

Declining Grants Means Declining Support for Charities

Another way of visualizing how these two different approaches have notably different outcomes on the grantmaking capacity of foundations is to illustrate what it means for a large charity which might depend on grants from foundations to support its charitable operations. For illustrative purposes, we use St. Jude Children’s Research Hospital as an example of a charitable organization that might depend on long-term support from foundation grants. Using the most recent annual expenses of St. Jude’s we can get a rough idea how much of the charities operating expenses could be covered by the same foundation in the previous simulation model, under the 5% rule versus 12% rules.¹²

Figure 2 below shows that after ten years, both foundations subject to different rules would be able to support almost 80% of St. Jude’s current operating expenses. After thirty years the foundation subject to the 5% rule would still be able to support more than 70% of current expenses, but the foundation subject to 12% rules would only be able to cover around 1/6th (15%) of expenses. By the end of the fifty-year simulation period, a foundation under the 5% rule would still be able to provide enough support to cover two-thirds (66%) of current operating costs, while a foundation subject to 12% rules would only be able to cover about 3% of St. Jude’s current operating expenses.

Ensuring Sustained and Reliable Support for Charities

The 5% minimum distribution rule, a cornerstone of the regulatory framework for private foundations in the United States, has demonstrated its efficacy in striking a delicate balance between addressing immediate charitable needs and ensuring the long-term sustainability of philanthropic endeavors. Donative statistics show foundation giving is making up a growing share of total charitable giving over time.

In 2000, foundation giving made up 11% of total charitable donations. By 2010 this had risen to 14%, and by 2022 it was 21%. This demonstrates the charitable community’s growing dependence on foundation grants, acting as a vital lifeblood for countless charities whose missions would falter without this essential support.

While critics advocate for a more aggressive payout requirement to combat concentrated wealth, a comprehensive forecast simulation model using the Ford Foundation as an example reveals that a higher payout requirement, as proposed by critics, could have detrimental consequences on the long-term grantmaking capacity of foundations. Under 12% rules, foundations may initially provide larger grants to charities, but this windfall diminishes rapidly as foundation assets are depleted.

In contrast, foundations adhering to the 5% rule consistently demonstrate a more substantial and sustained commitment to charitable causes over the long term. The fifty-year projection underscores the significant impact on grantmaking capacity, with a foundation operating under the 5% rule contributing nearly $21 billion more to charity than one adhering to 12% rules.

Furthermore, the analysis extends to the perspective of a large charity, exemplified by St. Jude Children’s Research Hospital, highlighting the tangible implications for organizations dependent on long-term support from foundations. The 5% rule enables consistent and substantial support for such charities over the simulation period. 12% rules result in a sharp decline in funding after an initial surge, ultimately providing only a fraction of the needed long-term support.

In navigating the discourse around private foundation regulations, it is imperative to consider the nuanced interplay between short-term impact and sustained, meaningful contributions to charitable causes. The current regulatory framework, with its 5% minimum distribution rule, strikes a delicate equilibrium that optimizes the dual objectives of immediate philanthropic impact and the enduring support required for addressing complex societal challenges over the long haul.

Mentioned on this page

Philanthropy Internal Revenue Service Ford Foundation The Vanguard Group Henry Ford Institute for Policy Studies Tax Reform Act of 1969 World Wide Web