New taxes could reshape how endowments think about almost everything (updated)

Educational institutions face higher taxes

In early July, President Trump signed the sweeping tax and spending cuts bill (the “One Big Beautiful Bill Act”)” into law. The legislation extends tax cuts in the 2017 Tax Cuts and Jobs Act (TCJA) that were scheduled to expire this year, while adding new ones.

The law replaces the current flat 1.4% excise tax on the net investment income of certain private colleges and universities’ endowments with a tiered structure as shown in Exhibit 1, depending on several variables, including the value of the endowment and the number of full-time students who meet certain other requirements¹. Previous drafts of the bill had proposed excise tax rates as high as 21% for the richest U.S. endowments.

Foundations, however, came away unscathed. Previously the draft bill had proposed a tiered tax scheme of as much as 10% on larger foundations, though this proposal was removed from the final bill. Certain private foundations will continue to be subject to a flat 1.39% excise tax rate on their net investment income.

Exhibit 1: Endowment excise tax proposal

Source: H.R.1 - https://www.congress.gov/bill/119th-congress/house-bill/1. July 4, 2025.
​* The term student-adjusted endowment means the aggregate fair market value of the assets (determined as of the end of the preceding tax year), other than those assets which are used directly in carrying out the institution’s exempt purpose, divided by the number of eligible students of the institution.

The tax increase effectively imposes an additional return hurdle on these nonprofit institutions, making it more challenging for them to meet their long-term return objectives. In response, these organizations may wish to adjust their investment strategies by raising their return and risk targets, focusing on maximizing after-tax returns, and/or reducing their annual spending.

Strategies to potentially maximize post-tax returns

There are several strategies taxable nonprofits can employ to enhance after-tax returns. These include adjustments to strategic asset allocation, careful selection of managers and funds, more deliberate use of active asset allocation tilts, implementation of more tax-efficient strategies, and the adoption of flexible withdrawal schedules.

1. Strategic asset allocation

• Target higher returns. Taking on more risk–typically by increasing equity exposure–may be necessary to achieve a higher pre-tax return to help offset the impact of taxes.
• Incorporate selective private assets, especially in private equity. Historically top-tier private equity funds have helped boost returns compared with investing solely in publicly traded equities. Private equity investments can be particularly advantageous in this context, as their long-term time horizon may help defer the realization of taxable net income. For other private assets that are income-oriented, it is important to assess the returns on an after-tax basis to ensure that absolute returns are high enough to warrant an allocation.

2. Manager and fund selection

Returns after-tax are hard to estimate at the asset class level, and at the fund or manager level due to the unpredictability of realized gains. As a result, tax-sensitive allocators must weigh their conviction in expected pre-tax returns (including potential excess returns) against the potential tax drags associated with each building block in their portfolio. In some cases, certain funds or managers may offer attractive returns on investments even after accounting for taxes. When such strategies are hard to find, other options to help maximize after-tax returns may include:

• Allocating to more passive funds since these tend to trade and distribute realized gains less frequently than active strategies.
• Allocating to tax-aware active managers who proactively harvest tax losses and seek to offset realized gains where possible.
• Allocating to ETFs (both active and passive) as their unique structures provide more favorable tax treatment compared to mutual funds and other commonly used institutional fund structures.
• For larger organizations, investing through tax-managed separately managed accounts (SMAs) where tax-loss harvesting at the individual security level can be an effective tool to minimize realized net income.

3. Active asset allocation and rebalancing

Given the need to target higher pre-tax returns, some endowments and private foundations may want to consider tilting their portfolio toward their highest conviction asset allocation ideas. Active tilts should avoid unnecessary turnover and be guided by a tested and risk-managed process. This strategy should only be implemented if the expected net income or gain from these tilts is higher than the expected tax drag. In addition, organizations may wish to widen rebalancing bands to minimize realization events caused by programmatic rebalancing processes.

4. Withdrawals

Withdrawals from investments to support a nonprofit's annual spending needs could result in realized net income, which may trigger tax liabilities for organizations subject to the tax.

• To mitigate this, we recommend raising cash opportunistically to fund annual spending, specifically during periods of weak portfolio returns, rather than adhering to a fixed quarterly or annual withdrawal schedule.
• For endowments and private foundations with more spending flexibility or a strong focus on preserving long-term real wealth, another option is to lower their annual spending rate to minimize taxes. This option must be carefully weighed against other trade-offs, particularly those related to advancing the organization’s mission.

Conclusion

For investors who may be subject to higher taxes and who engage Fidelity as their outsourced chief investment officer (OCIO), we recommend a hybrid approach: modestly increasing the return and risk profile of their strategic asset allocation, incorporating private equity, and integrating tax-efficient strategies where appropriate—without compromising our highest-conviction investment ideas.

1. Certain private colleges and universities mean eligible educational institutions that (1) which had at least 3,000 tuition-paying students during the preceding tax year; (2) more than 50% of the tuition-paying students of which are in the U.S.; and (3) the student-adjusted endowment of which is at least $500,000.