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Tapping A School's Investment Savvy


By Anne Tergesen Envious of the 15%-plus annual returns that Stanford, Harvard, and many other elite universities have earned on their endowments in recent years? Now a growing number of schools are allowing alumni and other donors to invest alongside their endowments. The hitch: You have to be willing to donate at least $100,000 via a charitable remainder trust. That donation will provide you with an immediate tax deduction and an income for life but will stay with the university when you're gone. "This gives people with a charitable inclination who don't have a great deal of wealth access to some of the best money managers in the world," says Phil Buchanan, director of gift planning at Duke University.

For a donor, the wisdom of such a strategy depends on factors such as age and tax bracket: The longer a donor's life expectancy and the lower his or her tax bracket, the greater the potential payoff to piggybacking on an endowment.

In recent years, more than two dozen schools have petitioned the Internal Revenue Service to allow such charitable trusts to invest in "units"—sort of like mutual fund shares—that track their endowments. This unit structure is necessary because some of the colleges' investments, such as leveraged hedge funds, cannot be held directly by the trusts without onerous taxation of their profits.

Harvard, the first to get such a ruling in 2003, says donors have invested more than $500 million of trust assets alongside its endowment. In recent months a slew of others, including Duke, Massachusetts Institute of Technology, Notre Dame, Princeton, Stanford, and the University of Michigan, have received similar rulings. Still others, such as Columbia, the University of California at Berkeley, and the University of Virginia have filed applications or are weighing such a move. "Many schools with endowments that have generated superior returns have jumped on this bandwagon," says David Leibell, partner at Cummings & Lockwood, a Stamford (Conn.) law firm.

To tie part of your fortune to an endowment, you must first spend about $3,000 to $5,000 to set up a charitable remainder trust. Most donors fund these trusts with appreciated stock. The trust, which can sell the shares tax-free and invest the proceeds in the endowment, will pay you (or any beneficiary you choose) at least 5% of its fair market value each year for a set period, generally for as long as you live. The payout rate is set at the outset by taking into account such factors as interest rates and the age of the person receiving the income.

TAX WRINKLES

The more a trust earns, the greater its value, and the higher the payments. For example, if your $100,000 trust has a 5% payout, you'll get $5,000 the first year. If the assets jump to $120,000 the second year, you'll receive $6,000. Should the trust decline, you'll get 5% of the lower value. At your death, whatever remains goes to the university.

Donors have some tax issues to consider. Under the IRS rulings, they would have to pay ordinary income tax at rates of up to 35% on most, if not all, of the trust income. In contrast, if a trust holds stocks, long-term capital gains and qualified dividend income face a maximum 15% tax rate.

The key question is whether the endowments' returns will be enough to more than make up for the higher taxes. The answer, of course, depends on such unknowables as future returns and tax rates. Yale, whose endowment has earned an annualized 17.2% over the past decade, says it could take as many as 10 years for those investing with its endowment to come out ahead. That's why Yale, which received a favorable ruling from the IRS, has opted against offering an endowment-based investment option.

Be aware that once you name a school as your trust's ultimate beneficiary, you cannot change your mind. Moreover, your trust's returns may not exactly match the endowment's, because the university will have to keep some cash on hand to make your payouts. Still, "many people are hell-bent on doing this," says Buchanan. Those returns are just too irresistible.

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