Many Large Private Foundations Fail to Pay Out 5% of Assets. Here's Why

In a March piece in the New York Times, David A. Fahrenthold and Ryan Mac reported that Elon Musk’s Musk Foundation did not meet the IRS requirement to distribute 5% of the fair market value of its assets for charitable purposes in 2021 and 2022.

In 2022, for example, the Musk Foundation disbursed $160 million — $234 million less than required by law. The foundation “has not released details of what it gave away in 2023, or whether it made up its shortfall from the year before,” Fahrenthold and Mac wrote. “If it did not, it could owe a penalty tax equal to 30 percent of the remaining shortfall from 2022.”

Time will tell if the richest man in the world’s foundation closes the gap and avoids a penalty — which, by coming out of the foundation’s coffers, would mean less grantmaking dollars for nonprofits. But the Musk Foundation isn’t the only funder that has had trouble hitting the 5% benchmark.

John Seitz is the founder and president of FoundationMark, which tracks the investment performance of private foundations. He recently crunched Form 990 data from the 40 largest U.S. foundations by total assets and determined that 17 of the 36 for which information was available for the last five years failed to hit an average 5% payout during that timeframe.

Seitz cited two reasons for these foundations’ underperformance. The first, ironically enough, is the surging stock market, which has dramatically increased foundations’ wealth. “From a practical point of view, that means [foundations] either give a lot more money to the same charities or increase the number of charities that receive support,” Seitz said via email. “It sounds like a very high-class problem, but the budgeting and vetting process of distributing that sum of money shouldn’t be underestimated.”

In addition, trustees’ desire to maintain a foundation’s perpetual status, coupled with a lack of timely visibility into their investment returns, often obligates them to adopt a more conservative grantmaking posture. Disbursing too much money now, even in flush times, can imperil their ability to provide sustained funding for grantees in the future.

The 5% payout rule: A quick primer

The 5% payout rule has been in place since 1976, when Congress reduced the figure from 6% after foundations, citing market turmoil and high inflation, argued that by hitting the target, they would effectively run out of assets and, by extension, grantmaking dollars.

Foundation assets themselves can be divided into two piles. The first consists of charitable use assets, which include things like art and office buildings, and are not used to calculate the 5% payout.

The second — noncharitable-use assets — includes monies invested in stocks, bonds, hedge funds, private equity and real estate. These assets constitute the foundation’s endowment and form the basis for calculating the 5% payout.

The 5% figure can include other qualifying distributions like administrative and travel expenses, as well as salaries. “In general,” notes the Council on Foundations, “grants constitute 90 to 95% of qualifying distributions.”

Seitz accessed the numbers from 40 foundations’ tax forms and calculated the payout ratios by dividing each foundation’s qualifying distributions — which again, includes non-grantmaking expenses — by the net value of its noncharitable-use assets. Since a foundation’s asset levels can fluctuate due to market performance, “many foundations use multi-year distribution averages to smooth levels of grantmaking and avoid large swings in outgoing contributions,” Seitz said. Therefore, the key metric in Seitz’s analysis is each foundation’s five-year average payout ratio.

This five-year window is also important because it pertains to how the IRS penalizes foundations that don’t distribute 5% of noncharitable-use assets. As the Times piece suggested, the agency typically allows foundations to compensate for payout shortfalls in future years. Therefore, the five-year payout average in Seitz’s analysis provides a more robust look at foundations’ long-term performance. (See here for more information on how the IRS penalizes foundations that fail to meet the 5% payout ratio.)

With that as a preamble, let’s see how the largest 40 foundations by total asset size fared in hitting the 5% threshold.

The largest 40 foundations ranked by five-year average payout ratio in percent

Simons Foundation: 11.8
Bloomberg Family Foundation (4-year average): 11.7
Walton Family Foundation: 10.6
Bill & Melinda Gates Foundation: 10.2
Charles and Lynn Schusterman Family Foundation: 9.3
Laura and John Arnold Foundation: 8.7
Open Society Institute: 7.7
The JPB Foundation: 7.4
Sergey Brin Family Foundation: 7.1
Rockefeller Foundation: 6.2
Ford Foundation: 6.0
The California Endowment: 6.0
David and Lucile Packard Foundation: 5.9
W.K. Kellogg Foundation Trust: 5.8
Andrew W. Mellon Foundation: 5.8
John D. & Catherine T. MacArthur Foundation: 5.5
Annie E. Casey Foundation: 5.5
Good Ventures Foundation: 5.3
Robert Wood Johnson Foundation: 5.2
The Leona M. & Harry Helmsley Charitable Trust: 5.2
James Irvine Foundation: 5.1
Conrad N. Hilton Foundation: 5.1
Kresge Foundation: 5.1
Foundation to Promote Open Society: 4.9
Carnegie Corporation of New York: 4.9
Charles Stewart Mott Foundation: 4.9
Gorden E. and Betty I. Moore Foundation: 4.7
Robert W. Woodruff Foundation: 4.7
Margaret A. Cargill Foundation: 4.7
Mother Cabrini Health Foundation (4-year average): 4.6
Duke Endowment: 4.6
William Penn Foundation: 4.5
William and Flora Hewlett Foundation: 4.4
Alice L. Walton Foundation (four-year average): 4.4
Crankstart Foundation: 4.3
Chan Zuckerberg Initiative Foundation: 4.2
Lilly Endowment: 4.1
Knight Foundation: 3.4
Carl Victor Page Memorial Foundation: 3.1
Musk Foundation (two-year average): 3.0

Living donors lift all boats

Perhaps the most striking takeaway is that among the ten foundations with the highest five-year payout ratios, only two — the Rockefeller Foundation and Walton Family Foundation — were not established by a living donor. (Jim Simons, whose namesake family foundation came in at No. 1, passed away this year, and his widow and foundation cofounder Marilyn sits on the board.)

Seitz attributes the higher payout ratio among living donor foundations to the fact that, unlike older and more established legacy foundations, their namesakes make periodic contributions in cash, stocks or real estate. As a result, these donors “know that there is more money that will be hitting their foundation at some point,” he said, which enables them to confidently eclipse the 5% figure without having to worry about imperiling the foundation’s perpetual status — assuming, of course, they’re concerned about perpetuity in the first place.

We can also expect reasonably robust giving from this subset of living donor foundations moving forward. Of the 10 foundations with the highest five-year payout ratios, five were stood up by some of the most philanthropically active Giving Pledgers out there — the Simonses, Michael Bloomberg, Bill and Melinda Gates, Lynn Schusterman and the Arnolds. In addition, Bloomberg has pledged to transfer his majority stake in his company, Bloomberg LP, to Bloomberg Philanthropies, and Gates plans to eventually sunset his foundation.

Zooming out, for the most recently reported year, the foundations’ combined noncharitable-use assets — that is, the pile of assets from which they must take the 5% disbursement — was $328 billion, and $271 billion without the Gates Foundation included in the data set. This is money the foundations have set aside for future grants, and the figure will increase commensurately over time.

However, it’s precisely because these numbers are so large that commentators are calling on Congress to increase the foundation payout rate to as high as 10% so more money can flow to nonprofits grappling with challenges in the here and now. Opponents of such measures argue that unless a foundation is buttressed by incoming donations, a higher payout ratio that exceeds its investment returns would shrink its assets — and by extension, its grantmaking outlays — to zero and effectively force the foundation to wind down. Reformers counter that a higher payout rate that forces foundations to sunset in 20, 50 or 100 years justifies unlocking a torrent of additional funding to ameliorate present-day suffering and set up nonprofits for long-term sustainability.

“Giving has ramped up”

Setiz calculated that, thanks to a surging stock market, the median disbursement for these 40 foundations was $400 million in 2022, up from just over $200 million in 2018. “As assets have increased, giving has ramped up,” he said. So why did 39% of the 36 foundations that made available data across the previous five years fail to average a 5% payout ratio?

One complicating factor is that with the value of their noncharitable assets going through the roof, some foundations may have lacked the capacity to effectively give away an exponentially larger 5% of the pile.

Consider the Chan Zuckerberg Initiative Foundation. It was established in December 2015, and according to Seitz, it received $5 billion in incoming contributions from 2016 and 2018, but “didn’t give much away for the first several years.” However, it subsequently staffed up so that by 2022, its payout ratio stood at a robust 7.1%.

It’s worth noting that foundation trustees aren’t the only philanthropic stewards who worry about thoughtfully moving enormous sums of money out the door in a compressed time frame. Silicon Valley wealth managers have a term — “the pause” — to describe how tech’s newly minted uber-rich pump the brakes on robust giving in the wake of a sudden wealth event. Better to sock away the money into a donor-advised fund, the thinking goes, than disburse it irresponsibly.

Another consideration that may contribute to a foundation’s inability to hit 5% is the fact that trustees don’t know precisely what their target 5% figure is in dollar terms until well after the end of the year — again, this is calculated by dividing its qualifying distributions by the net value of its non-charitable use assets. “By definition, foundations can’t calculate their average assets in time to get money out the door,” Seitz said. “It’s basically mechanical. Foundations with exposure to hedge funds, real estate, venture capital and private equity might not get statements until a couple of months after the books close.”

Given this lack of visibility, trustees may take a more conservative approach in determining their payout ratios in case their investments took a beating in the preceding year, which could erode their endowments to the detriment of current and future grantees. Replicate this calculus year over year, and it can explain why some foundations clock in at under 5%. In contrast, those helmed by living donors, cognizant that billions of dollars in incoming contributions are on the horizon, frequently blow past the figure.

Bottom line? It’s always risky to view private foundations as a monolithic group. “There may be a ‘survivor’ bias, and by this, I mean large, historic [foundations] tend to stick to the 5% figure, while others have spent down and are no longer significant,” Seitz said. “There are life cycles to many foundations, as not all intend to be perpetual.”

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