Creating an Inactive Funds Policy
Imagine the following scenarios:
- A donor advisor has not made a recommendation from a donor advised fund for two years.
- An agency has requested that your community foundation not make a distribution from an agency endowment until the agency requests a distribution at some point in the future.
- A fiscal sponsorship project has lost momentum and the funds are sitting unused.
Do you have a policy that guides how your community foundation handles these situations? If not, now is the time to put one in place.
Why should a community foundation have an inactive funds policy?
The Council recommends establishing an inactive funds policy for a number of reasons. First, a policy helps guide the community foundation’s responses to scenarios like those described above and allows the community foundation to provide a consistent message to fundholders. Second, a policy helps ensure that the funds at the community foundation are actively benefitting the community. Third, a policy helps address policymakers’ concerns about funds that do not make periodic distributions—concerns which have prompted some to propose solutions such as mandatory payout requirements for donor advised funds.
As one indication of policymakers’ interest in this issue, the IRS’s Donor-Advised Funds Guide Sheet, used by IRS personnel reviewing applications for new charities with donor advised fund programs, asks whether there are provisions in fund agreements for investments and distributions if a donor’s account is inactive. The guide sheet instructions explain that the question seeks to address the issue of whether the organization has a provision to ensure continuation of distributions. Regarding a related question, which asks whether the organization requires an annual minimum distribution from a fund, the instructions state, “[w]ithout a mechanism to ensure that distributions from donors’ accounts or funds are distributed, the organization may not be able to describe how it intends to fulfill its tax exempt purpose.” While the Council does not advocate for a fund-by-fund payout requirement, we do believe that an inactive funds policy addresses some of the concerns that prompt policymakers’ discussions about such payout requirements.
What should an inactive funds policy include?
The policy may be brief, but should include several basic elements: statement of applicability, definition of an inactive fund, guidelines for how inactive funds will be handled, and any exceptions to the policy.
While many inactive funds policies focus on donor advised funds, such policies should cover all funds.
Definition of an Inactive Fund
Inactivity is often defined as a period in which there is an absence of grant recommendations. The period of inactivity that qualifies a fund as being “inactive” varies among community foundations but often falls within the 2–5 year range. In the commercial donor advised fund context, the IRS’s actions indicate that they believe 3 years is an appropriate time period. A policy that allows a fund to remain inactive or dormant for more than 5 years will not likely be looked on favorably by regulators since 5 years is a long period for no distributions to be made from a fund.
While community foundations typically make periodic attempts to discuss the issue of inactivity with fundholders before the fund reaches the inactive status, most policies will first require the community foundation to make at least one attempt to contact fund representatives to discuss the intentions of the fund once a fund has officially become “inactive.” The second step of a policy will typically provide that if no activity occurs after a brief period following the last attempted contact, the community foundation will proceed with foundation-directed distributions from the fund.
Foundations vary with regard to what then happens to the fund. Some community foundations make a distribution from the fund to an unrestricted fund, in accordance with the fund’s spending policy. Caution should be used to assure that any legal restrictions placed on the fund by donors to the fund are honored. In the case of advised funds, other policies provide that the separately named donor advised fund is terminated and the assets in that fund are transferred to the community foundation’s general community fund.
A comprehensive policy will also provide a route for fundholders to allow the accumulation of funds for investment in a long-term charitable goal; for example, the establishment of a larger grant for a capital project if approved by the community foundation. If a fundholder wants the fund to accumulate assets for a specific purpose, it is prudent to document the purpose; an effective approach to documentation is to have the fundholder submit a written request outlining the charitable goal and a timeline for reaching that goal. With such a request in place, the community foundation would retain the authority to approve an exception to the inactive funds policy for that particular, long-term charitable goal. By establishing such a process, the community foundation can show that it has active oversight of the funds and that a plan is in place for the use of the funds even if they are not being immediately distributed.
Where should the inactive funds policy be located?
Options for placement include fund agreements, fund guidelines, or a separate policy. While the IRS’s guide sheet on donor advised funds suggests that IRS agents look for the policy in fund agreements, placing the policy terms in an agreement may reduce a foundation’s flexibility if its policy changes. Instead, it may be prudent to include such a policy in the fund guidelines or in a separate policy which could be referenced within the fund agreement (e.g., “This fund is subject to the Community Foundation’s policy on Inactive Funds, which may change from time to time.”)
Of course, a policy alone is not sufficient; the community foundation also needs to establish systems for following the policy. In creating or reviewing your foundation’s inactive funds policy, you have some flexibility, so think through its implementation as well. Finally, as with any significant policy, working with your local counsel will ensure that your policy meets the needs of your foundation without raising other concerns.