Looking to Get Out of the Pool

As planned-giving option loses favor, many charities reorganize costly funds

Twenty years ago, charities were touting a planned-giving option known as a pooled-income fund as an appealing way for donors to support a cause and, at the same time, earn substantial income. Today, many of those same charities are scrambling for ways to get rid of the costly funds, or at least to reorganize them.

To be sure, plenty of pooled-income funds are still thriving, particularly at colleges and universities. But at many smaller charities, the funds have fallen out of favor with donors and become increasingly costly to run.

The main reason for the funds’ drop in popularity has been the decline over the past two decades in interest rates and bond yields, which directly influence how much income donors earn from the gifts each year. In a pooled-income fund, organizations collect money from a number of donors and invest it primarily in interest- or dividend-earning assets. Each donor receives a share of the earnings based on his or her share of the total pool, and when the donor dies, the value of his or her share of the pool’s assets passes to the charity.

When interest rates were in the double digits in the late 1970’s and early 1980’s, the pooled funds were considered to be an attractive gift option for donors seeking income from their contributions. But as interest rates have dropped over the years — to about 5 or 6 percent today — pooled funds have posted lower and lower returns and have attracted less and less interest from donors and charities.

In fact, many pooled funds have been relatively inactive for the last decade, garnering few contributions and even fewer new donors. And, as the funds shrink, the cost of running them is eating up an increasingly large percentage of the assets that non-profit organizations can ultimately expect to receive.

“A lot of charities out there have small pooled-income funds that are a burden,” says Frank Minton, a planned-giving consultant in Seattle. “Now that these funds have been sitting around all these years, charities are now trying to do something about them.”

Some charities are simply shutting down the funds. In those cases, organizations and donors share the assets that are left in the fund according to a specific formula. Charities also may ask donors to give back their portion of the money to the organization as a new donation.

Other charities have chosen to close the funds to new participants. When all the current donors or their beneficiaries die and all the money is awarded to the charity, the funds are terminated.

Alan Spears, director of major and planned gifts at the Indiana University Foundation, says that strategy is “the least disruptive to donors.” Donors to pooled-income funds, he says, often are elderly and may be reluctant to see the funds close prematurely, particularly if they count on the income they receive from the funds.

But non-profit organizations that have chosen to keep the funds alive for the sake of their donors must now find ways to minimize the expense of maintaining the funds. Even the smallest funds can cost at least several thousand dollars each year to administer.

No national data exist, but information from individual banks and trust companies across the country demonstrate that many charities have already closed their funds, while many more may be poised to do so.

According to State Street Corporation, a financial-services company that manages assets for non-profit groups, 75 of the 300 pooled-income funds that the company was managing in 1993 were gone by last year. “A few funds may have left and are managed elsewhere,” says Daniel Farley, an official at State Street’s Charitable Asset Management Group, in Boston. “But it’s safe to say that most of the 75 were closed — either shut down while there was still money left in them or allowed to die out after all the beneficiaries died.”

Since donors’ earnings from pooled funds are based only on the income from investments — and not, for example, the total appreciation of the assets in the fund — the funds are usually heavily invested in bonds and other low-growth investments that generate interest. The funds typically hold relatively few stocks, which often pay out little, if anything, in dividends. Thus, not only has the funds’ ability to generate income been hurt by falling interest rates, but they also have not benefited from the booming stock market of recent years.

By comparison, other types of planned gifts — like charitable remainder trusts, which are more tied to the performance of stocks — have gained in popularity. At the same time, gift annuities, which offer fixed payout rates that usually range from 7 to 12 percent, also have earned favor over pooled funds, which have a variable — and usually lower — payout rate.

Today’s most successful pooled-income funds typically got off to a good start in the high-interest days and are now large and stable enough to keep attracting gifts.

Princeton University, for example, has not done anything in the last two years to promote its three pooled-income funds, and despite recent changes in investment strategies to try to maximize returns, the funds still pay out only 2.5 to 7 percent each year. Nonetheless, donors paid nearly $1.5-million into the funds last year — which together are worth about $56-million.

Other charities have shown recent growth in their funds, too. According to Internal Revenue Service data, from 1994 to 1997 — the latest year for which figures are available — the number of pooled-income funds run by charities rose by about 5 percent, while assets in the funds rose 49 percent.

But the tax agency’s figures do not tell the story of the many small and medium-sized charities around the country that are struggling with their relatively tiny funds. Among them:

* Lutheran Social Services of Illinois, in Des Plaines, has only two donors and $28,000 left in its pooled-income fund. The most the 14-year-old fund ever held was $50,000 from six participants. Concerned about the expense of maintaining the fund, charity officials are considering asking the remaining donors to take their money out of the fund and either give it outright to the charity or convert it into another income-producing gift, such as an annuity.

* A San Francisco private school that never had more than two participants in its pooled-income fund — which is worth a total of $58,000 — is also considering closing its fund. But school officials say that if the donors — who have not yet been contacted about the fund’s fate — would rather continue to participate, they will instead try to make running the fund affordable until they terminate it when the donors die. The school has already negotiated with a bank to pay considerably less than the annual management fee of $5,000 it paid in the past, but the school may switch to a less-expensive trustee altogether.

* To save money on managing their pooled-income funds, the Orthopaedic Hospital of Los Angeles and its fund-raising arm, the Los Angeles Orthopaedic Hospital Foundation, are planning to merge their funds. The combined fund, which would have about $250,000 in assets, will be cheaper to run because the administrative fees will be shared, according to Cary Tamura, a consultant who advises the hospital’s foundation.

He says that the two organizations had considered closing the funds, but decided that it was not worth bothering the donors — most of them elderly, including a few who counted on the income payments, he says.

In any case, notes Mr. Tamura, closing the funds would mean parceling out to donors shares of the funds that would be smaller than their original contributions. That’s because a donor’s gift is already earmarked, in total, for the charity. The donor’s only claim on the fund’s assets is what the charity would be likely to pay out to the donor over the years based on the fund’s earnings. A donor’s stake in a fund that is prematurely closed, then, is based on the present value of the total amount of money the donor would have received if the fund had continued at least until the donor’s death.

“A donor who gave us $10,000 10 years ago would not get that $10,000 back if we terminated the fund,” Mr. Tamura says. “We thought that kind of calculation would disappoint donors, and we didn’t want to do that.”

Some organizations have found a way to please donors whose take from a closed fund is smaller than their original gift.

In Florida, a state matching-gift program for community colleges meant that Orlando’s Valencia Community College Foundation — which closed its pooled fund two years ago — was able to add 67 cents for every $1 that donors took from the terminated fund and gave as a new donation to the college. To make such a new gift even more attractive, the foundation used the money from its pooled-fund donors to set up endowed scholarships at the college in their names.

“You have to find the right balance,” says the foundation’s president, Kenneth B. Woodbury Jr. “You’re not just making a business decision to put an end to something that may be a financial drain to your organization. You’re dealing with donors and your relationship with them, and you want to make sure they are OK with their options.”

In some cases, it may even benefit donors financially for them to convert their pooled-fund money into a new charitable gift.

When the Webb Schools — two private schools in Claremont, Calif. — closed their pooled fund in 1997, one donor used the money he was owed from his original gift of $90,000 — which, because of his age and the expected payout rate, had shrunk to about two-thirds the size — and bought a gift annuity. Because of the higher rate he earns on the annuity — a guaranteed 8 percent, instead of the 2 to 5 percent he was earning annually from the pooled fund — he now earns more income from his contribution each year. In addition, the donor was able to take another charitable tax deduction for his new gift.

“Closing the fund turned out to be a great opportunity to take something that wasn’t working well for the school or the donors and to turn it into something much better,” says John Helgeson, who was Webb’s director of development at the time the pooled fund was terminated.

Despite some potentially good results for both donors and charities, closing a pooled-income fund is not always a simple matter, according to legal and financial experts. State laws and provisions in the documents that govern each fund may restrict a charity’s ability to prematurely close the funds. In some states, charities may have to petition a court for approval to terminate a fund. And all charities have to be careful not to run afoul of federal law when splitting a fund’s assets between the beneficiaries and the charity. Charities can get in legal trouble if they seem to be giving undue benefits to particular donors.

Those difficulties — plus others — have prompted some charity officials to hold on to their poorly performing funds, hoping for a turnaround in interest rates. If the rates increase, they say, pooled funds will once again become an attractive investment for donors.

Other charity leaders are considering ways they might reinvigorate their pooled funds even if they cannot count on an upswing in interest rates.

Forrest Brostrom, executive director of development at the University of Southern California, says that his institution is thinking about ways to sell its two funds — which have a total of about 15 participants — to a new audience of donors.

One idea, Mr. Brostrom says, is to attract donors perhaps as young as 45 years old by switching from an investment strategy that focuses on producing income to one that focuses on growth. That way, he says, even if returns are small, assets in the fund will grow, producing more and more income for the donors as they age.

Such a strategy might just work for a large institution like Southern California, which, with a total of roughly $250-million in planned-giving assets under management, can afford to experiment with its pooled funds. But many more charities do not have the same wiggle room.

“We don’t have the resources or the time to get more donors,” says an official at the San Francisco private school that may terminate its fund. “We just need to rectify a situation that we really can’t afford.”