Are all nonprofit investments restricted?

Apr 25, 2022

Are all nonprofit endowments permanently restricted?

The word ‘endowment’ can cause lots of anxiety for nonprofit leaders. While there are plenty of myths on endowments, one of the primary worries is about permanently restricting dollars that are needed for the mission today.

Any time a donor makes a charitable contribution to a non-profit organization, they can decide whether the gift is used in one of three ways: unrestricted, temporarily restricted, or permanently restricted.

Unrestricted gifts

Any gift that is unrestricted can be used however the board deems appropriate in support of the mission of the organization. This is usually determined by an annual budget or if the gift is unexpected, can be allocated through a budget amendment. Unrestricted giving can be used for any purpose including future expenses. When soliciting donations by email or direct mail, most nonprofits ask for unrestricted funds. This is usually included in a clause on the donation form or in the gift acknowledgment.

Non-profits must follow the Federal Accounting Standards Board's (FASB) accounting guidelines; unrestricted gifts can be used for any purpose and accounted for under the program for which they were intended.

Temporary restrictions and donor designations

If a donor imposes a temporary restriction on how funds can be used, the organization is required to use the funds for the intended purpose. Typically, these gifts are either time-restricted and/or purpose restricted. For example, a gift given to support this year’s programming for kids is both restricted in time and purpose. Unless a gift specifies a time frame, the expectation is that the gift is used for the intended purpose until the gift amount is totally used. For example, if a $10,000 gift is given for kid’s programming and only $7,000 is used in the first year, the remaining $3,000 would be restricted to kids programming in the following year. One example of this is an expendable scholarship where the donor provides an amount of money annually to be directed to a student scholarship. If the donor accelerates the payment timeline, the scholarship amount remains the same.

One thing that surprises the nonprofits that we work with is that many of their appeals are actually temporarily restricted because the appeal requests funds for a particular program or purpose. One way to address this is to create opportunities for designations (e.g. restricted gifts) but also indicate that if the program is funded fully by generous donors, the remainder of the funds will be used for the organization’s greatest need.

Permanent restrictions

If a gift is permanently restricted, the donation can only be used for the specific purpose and the donation serves as the principal, with only the interest earned available for the mission. Examples of this include endowed scholarships, chairs, and buildings.

Permanently restricted funds tend to be rare because they involve a very specific donor intention. There are generally two types of donors who permanently restrict funds, those who give a large gift during their lifetime that they want to be used for a particular purpose in perpetuity. Most often these gifts are structured in a tax-advantaged way to the donor because the sale of an asset or business, an inheritance, or other taxable event. The second scenario that we see often is a bequest gift made in support of a particular program at a nonprofit. The donor has typically been a small or medium-sized donor to the organization (but occasionally has no giving history) and make a well-intentioned gift to provide long term funds to the organization in a way they could not have during life.

When donors are still living and active with the organization, restricted gifts present strategic opportunities for long term unrestricted gifts and sometimes even removing the restriction. With several of our community foundation and higher education clients, we are able to work collaboratively to identify opportunities for outright and planned gifts that reinforce the donor’s previous generosity.

With donors who are deceased, the law limits how a gift can be unrestricted but there are creative ways that sophisticated counsel can assist with utilizing the gift to do as best as possible. Most importantly, nonprofits should be proactive about what the best gifts might be and communicate with donors regularly even if they are not current donors, to ensure that the organization is not surprised by a restricted gift that doesn’t advance the mission in the way that either the donor or the organization intend.

When organization’s raise revenues in excess of expenses, either through earned or contributed revenue, the leadership can make a determination of how those funds are either used, saved, or invested for the future.

Even though many organizations confuse the two, a board-controlled fund is not the same as an endowment fund. Because the restriction was placed by the board of directors rather than the donor, a board-designated fund will show on the financial statement as "unrestricted." There are many examples of uses for a board-designated fund including a strategic reserve, a fund for deferred maintenance of a building, preparation for a campaign, or seeding a future endowment.

Organizations have many different options for these board-restricted funds. Many organizations simply keep this in a savings account or money market account. When interest rates are low and/or inflation is high, some organizations choose to invest these assets in a diversified market portfolio. Depending on when these funds would need to be used, a conservative investment strategy can aide organizations in reaching their specific goals.

Many Endowment Partners clients have worked with our experts to identify short- and long-term financial needs of the organization as well as ways in which unrestricted donor dollars can be used to advance the mission. If you have questions about board-restricted funds, a restricted gift, or your planned giving marketing, we’d love to speak with you!