The Truth About Private Foundations and the 5 % Payout Rule

Have you ever wondered about the rules that govern private foundations and their charitable giving? On November 16, Philanthropy Roundtable published a comprehensive policy primer entitled “Private Foundations and the 5% Payout Rule,” shedding light on the historical background, rationale and contemporary criticisms surrounding the 5% payout requirement for private foundations. In this blog post, we’ll dive into key insights from this primer to help you better understand the complex world of charitable giving. 

To comprehend the 5% payout rule, we must first journey back in time. This rule was first established in 1969 and later revised to strike a balance between ensuring that private foundations provide substantial resources for charitable activities in the near-term while enabling them to offer long-term support to charities. This rule mandates private foundations distribute 5% of their asset value annually for charitable purposes. 

Over the years, private foundations have proven to be an essential source of charitable giving. In 2022, they contributed over $105 billion in charitable donations, up from nearly $103 billion in 2021. Even after adjusting for inflation, private foundation giving has doubled in the past 15 years and quadrupled over the last 25 years. These figures illustrate the substantial role private foundations play in supporting various charitable causes, including education and social services. 

But why 5%? Existing research and available data consistently demonstrate the 5% payout rule comes closest over other proposals to preserving the purchasing power of private foundations. It ensures a steady and reliable source of funds for charities over the long run. Moreover, predictions of future investment returns suggest that foundation investments are likely to see returns of around 5% and possible even lower. Higher payout requirements would, therefore, result in a significant decline in real dollar payouts over time. 

In recent years, there has been a resurgence of populist rhetoric from critics of private philanthropy advocating for higher foundation payout requirements and other onerous new rules. Some of these critiques include calls for excluding administrative expenses and grants to donor-advised funds from being counted as qualified expenses toward the 5%  payout requirement. 

Our new policy primer offers a critical perspective on these proposed changes. It cites research and data on private foundation payout trends, suggesting these proposals are unwarranted and more likely to reduce charitable giving in the long run. Ultimately, such changes may hinder the most vulnerable members of our society, as they rely on the consistent support private foundations offer. 

The 5% payout rule for private foundations serves as a careful balancing act between current and future charitable activities. While there is growing advocacy for higher payout requirements and changes in measurement methods, a thorough analysis of the data and literature suggests these proposals are unnecessary –  and likely to stifle charitable activity. As philanthropy continues to evolve and adapt, it’s essential to ensure charitable giving remains a powerful force for good in our society, especially for those who need it most. 

Private Foundations and the 5 Percent Payout Rule

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