How Can a Foundation Generate Income and Preserve Its Assets Over the Long Term?

Sustainable distribution planning does not begin with the amount distributed by a fund. It begins with the foundation's responsibilities as set out in its governing documents.

The foundation should first determine which financial obligations will actually arise during the forthcoming planning period. These include regularly recurring expenses, grants that have already been approved, multi-year projects and foreseeable one-off payments.

A distinction should be made between fixed and flexible expenditure. Personnel costs, rental obligations and binding grant commitments often cannot be reduced at short notice. New projects or additional funding measures may, by contrast, be adjusted to the funds actually available.

This distinction produces a more resilient grant-making budget. The foundation can identify the minimum amount that must be reliably available and the proportion of its activities that may remain dependent on the development of investment returns.

The timing of payments is just as important as their amount. A foundation may generate sufficient income over the course of a year and still experience a temporary liquidity shortfall. This may occur, for example, where a fund makes its distribution only at the end of the year while grant-funded projects require monthly payments.

The distribution plan should therefore include a payment or liquidity calendar. This compares expected cash inflows with planned expenditure and makes clear when temporary funding gaps may arise.

Other sources of income should also be included. Distributions from investments are often an important source of funding, but they are not necessarily the only one. Donations, rental income and other recurring inflows may influence the foundation's short-term liquidity requirements.

Only after completing this assessment should the foundation determine which distributions from its assets are required. The sequence is important: The distribution offered by a product should not determine the foundation's funding requirements. Instead, the funding requirements should form the starting point for distribution planning.

A fixed distribution rate may provide guidance. It should not, however, be applied without considering the development of the assets, inflation, costs and the foundation's actual funding needs. A purely mechanical rule may lead to unnecessarily high distributions in strong years and unsustainable distributions in weaker years.

Investment return, distributions and liquidity are often treated as interchangeable. For a foundation, however, they represent different measures.

The economic return reflects the overall performance of the investment. It may include current interest and dividends as well as positive or negative changes in market value. Costs also affect the economic result.

A distribution, by contrast, is an actual cash inflow. It describes the amount paid to the foundation by a fund, a company or another asset.

The amount of a distribution does not automatically show how the assets have developed overall. A fund may make a distribution while also increasing in value. It may, however, also make a distribution while its unit price is falling.

To assess the distribution correctly, its underlying components must therefore be understood. It may be supported by current interest, dividends or realised capital gains. Depending on the structure, it may also be associated with a reduction in the capital base.

A payment described as a dividend is not necessarily treated as current income in the same way from an economic, accounting or tax perspective. A distribution may, for example, represent a return of capital. For a foundation, the correct classification may affect both the use of funds and the accumulation of reserves.

Available liquidity is another separate consideration. It refers to the funds that the foundation can actually access at the time they are required. An economic return is not automatically liquid. An unrealised capital gain, for example, increases the value of the assets but is not yet available as cash to finance a project.

Conversely, not every cash inflow may be used freely for the foundation's purpose. It may consist of restricted funds, an addition to the foundation's endowment, a return of assets or another inflow subject to specific requirements.

Gains realised from reallocating the foundation's endowment assets, referred to in German law as the Grundstockvermögen, must also be assessed separately. Under Section 83c of the German Civil Code, or BGB, such gains may be used to fulfil the foundation's purpose where this is not excluded by its governing documents and the preservation of the endowment assets remains assured. This does not amount to a general release of every realised capital gain for immediate expenditure.

For the purposes of distribution management, the foundation should therefore assess three perspectives separately: The overall economic development of the assets, the distributions actually received and the liquidity available for specific expenditure.

Only this combined assessment reveals whether the distribution policy is sustainable over the long term. A high pay-out may facilitate the foundation's activities in the short term and still be problematic if the assets continuously lose earning power after distributions, costs and inflation.

Investment returns do not develop in the same way every year. Grant-funded projects, by contrast, often require more reliable financing. A central task of distribution planning is therefore to reconcile these different patterns.

A foundation should not base all its recurring commitments on a particularly strong year in the capital markets. Otherwise, it may establish permanently higher expenditure that can no longer be covered by the available funds in a weaker year.

Conversely, a single weak year does not necessarily have to result in the immediate termination of long-term projects. This requires the foundation to have allowed sufficient room for fluctuating returns in its financial planning.

One possible approach is to distinguish between a core budget and a flexible grant-making budget. The core budget covers regularly recurring obligations. Additional projects are approved depending on the funds available, existing reserves and the development of the foundation's assets.

An internal distribution range can also support planning. Instead of specifying an unchanging amount, the foundation defines a target range. Within this range, the actual distribution can be adjusted to the foundation's funding requirements, income situation and asset development.

Another option is to use a multi-year reference value. This prevents the grant-making budget from being determined solely by the development of a single year. Particularly positive or negative capital market periods therefore have a less immediate effect on the foundation's ongoing activities.

Such an approach must not conceal losses or insufficient returns. Smoothing is only sustainable if the long-term development of the assets is reviewed regularly. If distributions are financed increasingly from reserves or asset sales over several years, the foundation must adjust its planning.

The distribution frequency should also be determined by the timing of the foundation's payments. Quarterly distributions are not automatically more advantageous than an annual payment. What matters is whether the timing and amount correspond to the planned expenditure.

If the foundation receives funds significantly earlier than required, it must make additional arrangements for their temporary investment. If the distributions arrive too late, the foundation must either maintain operational liquidity or sell assets at a potentially unfavourable time.

The distribution rules should be documented transparently. This includes defining who determines the annual distribution requirement, which data are considered and under which circumstances the existing plan may be amended.

Such a rule does not replace a decision by the responsible governing body. It does, however, create a transparent basis for that decision and prevents the grant-making budget from depending solely on short-term market movements or spontaneous assessments.

Reserves can help reconcile fluctuating returns with predictable grant expenditure. They are not, however, an unrestricted holding account for all funds that have not yet been spent.

Tax-privileged entities in Germany are generally subject to the requirement for the prompt use of funds. Under Section 55 of the German Fiscal Code, or AO, the relevant funds must generally be used for the tax-privileged purposes set out in the governing documents no later than the two calendar or financial years following their accrual. Under the current legislation, this specific requirement does not apply to entities with annual income of no more than EUR 100,000. Other requirements relating to the use of funds in accordance with the entity's governing documents remain unaffected.

This means that the relevant funds do not necessarily have to be spent in full during the year in which they are received. The statutory period provides a degree of flexibility for planning. It should not, however, be understood as general permission to accumulate funds indefinitely.

Section 62 AO permits different types of reserves to be accumulated under specified conditions. These include reserves for specifically planned tax-privileged purposes, replacement reserves and general reserves within the statutory limits. The applicable requirements differ depending on the type of reserve.

A reserve earmarked for a particular purpose may, for example, be appropriate where a foundation is preparing a larger project whose financing will extend over several years. This requires a sufficiently specific plan to exist at the time the reserve is established.

Reserves may also help make the grant-making budget less dependent on the returns generated in a single year. In a stronger year, funds may be retained within the legally permitted framework and subsequently used to finance activities that have already been planned.

Clear allocation is essential. Endowment assets, other assets, funds subject to the prompt-use requirement and reserves do not automatically follow the same rules. A cash amount may appear economically available while still being subject to a particular legal restriction.

The foundation should therefore document the source of the funds, the category of assets to which they belong and the purpose for which they are being used or reserved. This facilitates distribution planning and reduces the risk of confusing restricted funds with funds that are freely available.

The specific legal, tax and accounting treatment depends on the type of foundation, its governing documents, its tax-privileged status and the nature of the inflow. General distribution rules therefore cannot replace an assessment of the individual circumstances.

The management of the foundation's assets does not end when a distribution is credited to its bank account. Several weeks or months may pass between receipt of the payment and its actual use.

The foundation should therefore determine which proportion of the available funds is required immediately for ongoing payments. This amount must be accessible at short notice and should not be exposed to material fluctuations in value.

Funds for projects that have already been approved but are not due for payment until a later date can be considered separately. Their investment horizon depends on the expected payment date. The closer this date is, the more important availability and limited fluctuations in value become.

Long-term foundation assets follow a different logic. They should not be held entirely in short-term liquidity merely because individual grant payments are approaching. Separating the different time horizons prevents long-term return opportunities from being confused with short-term payment capacity.

Depending on the time horizon, possible instruments for the temporary investment of funds may include bank deposits, fixed-term deposits, short-dated bonds or money market funds. Selection should not be based solely on the interest rate offered.

Availability, maturity, credit quality, costs and potential concentration risks are also important. Even short-term instruments are not entirely free of risk. A higher interest rate may be associated with additional credit, liquidity or market risks.

A practical problem frequently arises when distributions automatically accumulate in a low-interest account. This may be appropriate if the funds will be required at short notice. If larger amounts remain unused for extended periods, however, this can reduce the foundation's earning power.

The opposite problem arises where funds that will shortly be required are reinvested in long-term or more volatile instruments. If the foundation has to sell the investment shortly before a grant payment, an unfavourable market environment may interfere with the planned use of the funds.

A regular liquidity forecast creates transparency. It shows the current cash position, expected distributions, funds that have already been committed and forthcoming payments. This enables the foundation to identify excess liquidity or a funding requirement at an early stage.

Responsibilities should also be defined clearly. It must be established who monitors distributions, who makes decisions concerning the temporary investment of funds and who ensures that the required amounts are made available for projects on time.

Distributions should therefore not be reported solely as income. Reporting should also show which amounts are freely available, already committed, allocated to a reserve or invested on a short-term basis.

This creates a connection between investment management, accounting and the foundation's day-to-day activities. It is precisely this connection that turns a distribution into a genuinely usable and predictable grant-making budget.

Ongoing income alone does not ensure either the foundation's capacity to fund its activities or the long-term preservation of its assets. What matters is how investment returns, distributions and liquidity are aligned.

A foundation should first determine its actual funding requirements and the timing of the associated payments. Only then can it assess which distributions are required and whether they can be supported by the long-term development of the assets.

Investment return and distributions should not be treated as the same thing. It is equally important to determine whether a cash inflow is freely available, legally restricted or attributable to a particular category of assets.

Multi-year planning approaches, a flexible grant-making budget and legally permissible reserves can help cushion fluctuations. They must not, however, result in a permanently excessive distribution or declining earning power being overlooked.

The period between a distribution and the use of the funds must also be managed actively. Funds required at short notice have different requirements from foundation assets invested for the long term.

The distinct value of effective distribution planning therefore lies in translating capital market outcomes into reliable foundation activities. It connects the development of the assets with the foundation's grant-making calendar and helps prevent today's expenditure from unnecessarily restricting its future capacity to act.

• What Are Foundation Investment Funds and Who Are They Suitable For?
• How Should a Foundation Invest Its Assets?
• Comparing Foundation Investment Funds: What to Look For
• Does a Foundation Need an Investment Policy and What Should It In

¹Distributions are not guaranteed.

This article is provided for information purposes only. The legal and tax information contained herein is not intended to constitute or replace legal advice, nor does it purport to cover all legal or tax considerations that may be relevant to the subject matter of this article. The information is not exhaustive and does not take into account the individual circumstances of any particular investor or group of investors. It cannot replace advice from a tax adviser based on the circumstances of the individual case. Although the information has been compiled with due care, no representation, warranty or guarantee is given as to its accuracy, completeness or currency.