Need for Tax Optimization, Liquidity Could Change ‘Endowment Model’

In the last decade, foundations and higher-education endowments have been subjected to new taxes, which—combined with current liquidity needs—are likely to change how those institutions operate in the future.

The 2017 passage of the Tax Cuts and Jobs Act introduced a 1.4% excise tax on certain large private college and university endowments, as well as some private foundations, and opened the door to increased taxes on these organizations. In 2025, the One Big Beautiful Bill Act went further.

Under the OBBBA, private nonprofit colleges and universities that enroll at least 3,000 students will be taxed at three different tiers on their “net investment income”:

• Endowments with between $500,000 and $750,000 in assets per student are taxed at the previous rate of 1.4%;
• Endowments with between $750,001 and $2 million per student have a 4% tax rate; and
• Endowments above $2 million per student face an 8% tax rate.

As a result, some private endowments are facing high tax bills at the same time colleges and universities need their endowments to work harder than ever before to support students. Higher taxes could also affect after-tax portfolio returns and could push some organizations to make adjustments to both operations and asset allocation. Endowments are also likely to have higher liquidity needs going forward as a result of sweeping federal funding cuts to research programs and student aid—factors which underline the need for portfolio allocation changes.

Change is already starting to happen in university policies, even if allocation changes have not been made public. Yale University announced a 90-day hiring pause, a 5% reduction in non-salary expenses, a delay of several capital building projects across the university, and a reduction in the merit pool used for annual salary increases for some university staff.

“The challenge right now is that there are layers to this law, and there are layers to what it means. Organizations are finding that it’s not just tax; the populations they serve could also have their funding cut in other ways or the rules are changing,” says Heather Myers, a partner in and the nonprofit practice leader at Aon. “You just kind of have to pull at the layers of the onion and say, ‘OK, I’m X organization, these are my needs, this is the state I am located in, this is where I get my funding’ and start reworking from there.”

A Shift in Posture

Many of the largest endowments are organized around the so-called “endowment model” of investing, which favors a total return approach and emphasizes alternatives to traditional stocks and bonds. As a result, endowment portfolios have tended to be less liquid, with the goal of generating better returns through the illiquidity premiums of private equity, venture capital, private credit and so on. This model works well for endowments which operate in perpetuity and therefore have the time horizon available to realize the higher returns these asset classes can provide over long periods.

However, sources say, the changing priorities at endowments and foundations may result in higher activity on the secondary market this year.

“Universities are facing a variety of strains at the moment,” Myers says. “So they might look to their endowments to work harder and also provide more liquidity. One of the aspects of OBBBA that isn’t tax[-related] is the elimination of GradPLUS student aid programs, which goes into effect for the [20]26-27 academic year. So: Many institutions are focused on what the role of the endowment might be there to fill the gap. That’s just one impact of many that could increase the need for liquidity.”

An analysis from Callan showed that if endowments start to shift to a tax-optimized approach from a total return investment approach, it will change the risk/return profile for a variety of investments. Dividends and realized gains on public equities, for example, are taxable. Interest income from fixed income is fully taxable under the new rules, with no deferral. Private equity distributions and embedded gains can create large taxable events when those are realized. Interest income on cash is also fully taxable with no upside and potentially negative real return. Gains in real estate can be offset with asset depreciation, but that, too, requires a tax-optimization strategy.

“The challenge right now for endowments is that they have fewer options than, say, private wealth investors if they want to focus on tax optimization because of their nonprofit status,” explains Brent Sullivan, a taxable investing specialist and the founder of Tax Alpha Insider.

Sullivan says it is unlikely that endowments will shy away from any particular asset class, but they may need to change some of the strategies they invest in to deal with their new reality.

“If the endowment is invested in a high-turnover hedge fund strategy, for example, that’s going to be very tax inefficient, and they might not be able to keep doing that without an offset somewhere else,” Sullivan says.

Similarly, if endowments are dealing with any lag in distributions to paid-in capital from their private equity or venture portfolios, that could make it difficult to effectively plan around the taxable events in those investments—at least in the short run, Sullivan says.

“If you are taxed on net investible income and that income is deferred, that’s helpful if you’re trying to figure out what you need to change, and it’s helpful long term if you remain fully invested,” Sullivan says. “But when that bill does eventually come due, endowments need to have a plan in place to mitigate the impact and won’t be able to lean on things like carry forwards of capital losses. Nonprofits face constraints in terms of what they can do there because of their nonprofit status.”

Looking Ahead

Apart from the immediate changes to how endowments are taxed, the longer-term question is whether the tax changes open the door to even higher tax rates in the future. The original draft of the OBBBA started with higher tax rates that were then walked down to the 4% and 8% figures through the negotiation process for the law. Sources say it is hard to know if that was all part of the negotiation or if it foreshadows potential future increases. That puts more pressure on endowments and foundations to tax-optimize now so that they are prepared for the long term.

States such as Massachusetts and Connecticut are also considering changes to their state tax codes that could add to the tax bill for endowments and foundations. If that happens and the U.S. enters an era in which endowments have lower total federal funding support and higher total taxes, it is likely endowments will shift further into investments that are tax optimized and provide higher liquidity.

“I wouldn’t be surprised to see the largest endowments expand the tax expertise they have in-house,” Sullivan says. “We’re still in the early stages in terms of these organizations understanding what they will have to change going forward. Having people on the inside with that knowledge base is going to be important, because we’re talking about structural changes for these organizations.”