As individuals, we prepare financially for retirement - to enjoy life without the daily responsibilities or distractions that full-time work entails. We insure ourselves against the probable day when we can no longer earn our current income.
Our retirement preparations require saving money now to bankroll our expected future spending. We may call ourselves ‘financially independent’ when we reach our savings target.
We don’t expect charities to become financially independent like individuals, but what if they could?
Financially independent charities and foundations would have all the money they need. They would not be held back by lack of donations, would not suffer the vagaries of donor giving levels and would not have cumbersome donor-requested restrictions. Charities with all the money they need could implement programs that comprehensively address underlying causative issues.
Financial independence for charities would provide security of current revenues. It would permit ‘retirement’ from fundraising with incremental new revenue arriving on schedule.
Charities could achieve financial independence via this blogger’s proposed but not-yet-established ‘Fund Generators.’ These fund generators will invest on behalf of charities for decades, eventually providing a steady and ever-growing income. Assuming a fund generator will eventually get built, there is still a critical catch - charities must provide the initial seed money.
Charities have expressed that they can’t afford to set aside seed money for an unknown future when all donations are desperately needed to solve today’s issues. However legitimate, this concern must be weighed against the benefits for future generations. Balance is key.
Creating financial independence for charities is a very new idea. To evaluate the desirability of going down that road, we fall back on what we know. We know saving for retirement as individuals takes a significant effort. Would charities face such an arduous task?
This blog will compare the effort some individuals are willing to make to save for financial independence against the comparative effort of a charity to do the same. Spoiler alert - charities could be financially independent with a minuscule fraction of the effort required for individuals. It just takes longer.
The effort required of individuals Society encourages individuals to save. Our government knows financially self-sufficient retirees curtail the need for costly social support programs. So the government provides assistance and incentives. For example, the government mandates retirement savings (via Canada Pension Plan, the ‘CPP’), promotes financial literacy and creates tax incentives for individuals to contribute to Registered Retirement Savings Plans (RRSPs).
Most individuals want to retire with an income equal to what they enjoy while working. By convention and experience, individuals need about twenty-five times their annual spending as savings to consider themselves ‘financially independent.’ Once savings reach 2,500% of annual spending, individuals may safely retire and enjoy 100% of their pre-retirement income for each retirement year.
An individual or couple with an annual income of $100K (for round numbers) would need $2,500K saved before retiring. That amount of savings is quite a lot for anyone to amass over an approximately forty-year career, but it can be done.
To save this amount, individuals sacrifice some spending during the saving-up period to gain independence. Let’s quantify the sacrifice one individual makes to save vs. another who maximizes spending.
Assume that both individuals earn $100K annually and pay 20% in taxes. For the individual who spends it all now, their maximum spending is an after-tax level of $80K per year without incurring any new debt. This individual will not accumulate any savings.
The saving individual contributes to an RRSP aiming for an eventual $2,500K retirement fund. Knowing the goal, we use a growth rate of 6.54%[i] over the typical forty-year career to determine the required annual savings must be $14K per year. Helped by government incentives, the second individual saves some taxes on their RRSP contribution. Assuming the marginal tax saved is 40%, the after-tax costs for the RRSP are 60% of $14K or $8.4K.
Therefore, this saving individual will have to reduce spending from $80K to $71.6K by forgoing annual spending of $8.4K (10.5% of $80K).[ii] The total amount the individual saves is $336K (336% of income) based on forty years times the annual $8.4K (10.5% of income) savings.
The effort required of charities
While individuals must plan to retire within their lifetime, charities have infinite time available. This expansive time horizon permits various savings and spending options unavailable to individuals. For example, charities can put a minimal amount of money aside just once and wait longer than the individual could practically endure.
Assume a charity allocates 5% of one year’s annual revenue to seed our proposed fund generator. If 5% seems steep, the charity could invest 0.5% and wait longer to retire, or perhaps invest 0.5% annually for ten years.
The fund generator invests the 5% over long periods until scheduled withdrawals back to the charity begin. Like individuals, a charity must reach the same goal of 2,500% of annual revenues to achieve financial independence. At the above used 6.54% growth rate, the charity could reach financial independence in Year 102.
A one-time contribution of 5% of revenues is all the input required from the charity. This total of 5% is 67 times [iii] smaller than our saving individual, who, as we saw above, must contribute 336% of their revenues.
The charity has foregone spending equal to a 5% donation for just one year. Compare that expense with the 10.5% foregone by our saving individual every year for forty years. The individual must endure 84 times [iv] less spending than a charity.
The charity has more options regarding withdrawals as individuals face a final curtain, and charities carry on. For example, if a charity were to wait twelve more years until Year 114, the fund would grow to over 5,000%. At this point, the charity could withdraw 2,500% to enjoy 100% annual revenue and let the remaining 2,500% double again by Year 126. In this way, the charity could continuously increase annual revenue by an additional 100% every twelve years.
Yes, reaching Year 114 for a charity takes far longer than Year 40 for an individual, but only 2.9 times longer, not 50 times longer. Our grandchildren will be the beneficiaries. How can this not be well worth the wait?
Conclusion:
We have shown:
An individual must set aside 67 times as much as a charity does as savings.
An individual forgoes 84 times the annual spending impact faced by charities.
All charities can benefit further by periodically adding 100% more to annual revenues.
The 5% starter amount charities forego is minuscule compared to the savings required and annual spending foregone by individuals. If this 67 times saving difference were expressed as a person’s height and the saving individual was 6 feet tall, the charity would measure one inch tall. Now that’s minuscule!
Yet today, even as we align to the effort made by many individuals trying to save for retirement, no one is excited about arranging now or even speaks of charities gaining financial independence. No actual charity is currently doing or considering savings to create our definition of financial independence.
Perhaps we ignore this opportunity for charities as we imagine the difficulty will parallel our individual efforts to achieve financial independence. We have shown this requires a minuscule comparative effort by charities.
Hopefully, this lack of action and interest is simply because no fund generators exist. When they do exist, charities should create their path to financial independence.
Do you think they will?
[i] Growth rate of 6.54% is based on investment earnings of 10.192 % (S&P and Dow lifetime combined averages) less 2.75% inflation and 0.9% wealth management fees. That growth rate over 40 years enables a savings account to reach 2,500% if 14% is contributed yearly.
[ii] 10.5% = spend reduction is derived by dividing $8.4K of forgone spending by the net $80K that the first individual, the non-saver, can spend each year.
[iii] 67 = the multiplier for saving individuals vs charity derived by dividing the 336% total contributions after 40 years by individuals by the 5% contributed as savings by a charity
[iv] 84 = the multiplier of annual revenue forgone by an individual vs charities derived by dividing 10.5% forgone spending per individual yearly times the 40 years by the 5% one-time spending forgone by a charity.
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