There are three types of endowments: true (permanent) endowments, term endowments, and quasi (board-designated) endowments. They differ in who imposes the restriction on the principal, how long that restriction lasts, and whether the institution can ever spend the underlying gift. A true endowment locks the principal away forever, a term endowment carries a restriction that eventually lifts, and a quasi endowment is a self-imposed designation the board can reverse whenever it chooses.
True (Permanent) Endowments
A true endowment, sometimes called a permanent endowment, is a gift the donor requires the organization to keep intact in perpetuity. The IRS defines permanent endowments as donor-restricted gifts “maintained to provide a permanent source of income, with the stipulation that principal must be invested and kept intact in perpetuity, while only the income generated can be used by the organization.”1Internal Revenue Service. Instructions for Schedule D (Form 990) If a donor gives $1,000,000 to fund a scholarship, only the investment returns on that million can be spent. The original gift stays untouched no matter what the institution’s finances look like.
The donor’s terms usually appear in a written gift instrument, which functions as a binding agreement between the donor and the institution. It sets out the purpose of the fund — a named professorship, a research program, a scholarship — and the institution is legally obligated to honor those terms. On financial statements, the principal shows up as net assets with donor restrictions, signaling that the money cannot be redirected.
Because the restrictions are permanent, the stakes for mismanagement are high. Institutions that ignore or violate donor restrictions can face lawsuits, and state attorneys general have authority to intervene when charitable assets are misused. State attorneys general are the primary enforcers of endowment restrictions and are responsible for making sure charitable assets are properly managed and used according to donor wishes.2National Association of Attorneys General. Charities Regulation 101 Historically, donors themselves had limited standing to sue over a breach, though a growing number of states now let donors or their representatives bring an action when an institution violates an endowment agreement.
Term Endowments
A term endowment carries donor-imposed restrictions that expire after a set period or once a specific event occurs. The IRS describes these as “endowment funds established by donor-restricted gifts that are maintained to provide a source of income for either a specified period of time or until a specific event occurs.”1Internal Revenue Service. Instructions for Schedule D (Form 990) A donor might, for example, restrict the principal for 20 years, or until a new building is completed. After that, the institution can spend both the principal and any remaining earnings.
During the restricted period, a term endowment behaves much like a true endowment. The institution invests the principal and uses only the returns for the donor’s stated purpose, and the funds are reported as temporarily restricted assets. Once the time period lapses or the triggering event occurs, the principal shifts to unrestricted status and the institution gains full control of whatever remains.
This structure suits donors who want their gift to grow through long-term investing but also want the institution to eventually have full access to the capital. A donor funding a research initiative might set a 15-year term, generating steady income during the active work and then releasing the principal for other priorities once the project wraps up.
Quasi (Board-Designated) Endowments
Quasi endowments, also called board-designated endowments or funds functioning as endowments, are different in kind: no donor restriction exists at all. The institution’s governing board voluntarily designates unrestricted funds to be invested and treated like an endowment. The IRS classifies these as funds that “result from an internal designation and are generally not donor-restricted and are classified as net assets without donor restrictions.”1Internal Revenue Service. Instructions for Schedule D (Form 990)
Because no external legal restriction binds these funds, the board can reverse its decision and spend the principal whenever it wants. A board might create a quasi endowment during a period of financial strength, investing surplus funds for long-term income. If an emergency arrives — a natural disaster, a sudden revenue shortfall — the board can vote to un-designate the funds and spend them right away. That flexibility makes a quasi endowment a planning tool, not a legal obligation.
Creating or reversing a quasi endowment typically requires a formal board resolution. The resolution normally specifies the amount being designated, the intended purpose, and the investment and spending policies that will apply. It also expressly reserves the board’s authority to modify, redesignate, or terminate the designation at any time.
Comparing the Three
The practical differences come down to three questions: who set the restriction, how long it lasts, and whether the principal is ever available to spend.
- True endowment: the donor sets the restriction, it lasts forever, and the principal is never available to spend.
- Term endowment: the donor sets the restriction, it lasts until a stated date or event, and the principal becomes available once the term ends.
- Quasi endowment: the board sets the designation, it lasts only as long as the board wants it to, and the principal is available whenever the board votes to release it.
How Endowment Spending Works
Endowments do not sit in a savings account. Institutions invest the funds across a diversified portfolio of stocks, bonds, real estate, and other assets, then distribute a percentage of the fund’s value each year for operations, scholarships, or the donor’s designated purpose. Most institutions set their annual payout between roughly 4% and 5.5% of the endowment’s market value, with the exact rate depending on investment performance and institutional policy.
The rate is intentionally conservative. If an endowment earns 7% to 8% on average but pays out only 5%, the remaining returns get reinvested, helping the fund keep pace with inflation. Spending too aggressively in strong years can leave the fund vulnerable during downturns; spending too little can starve current programs.
The Uniform Prudent Management of Institutional Funds Act (UPMIFA) is the primary legal framework governing how institutions manage and spend endowment assets, and 49 states have adopted some version of it. Many UPMIFA states include an optional provision creating a rebuttable presumption that spending more than 7% of a fund’s value in a single year is imprudent. The fund’s value for this calculation is typically determined by averaging quarterly valuations over at least three years, which smooths out short-term market swings. Spending below 7% does not automatically qualify as prudent — institutions still have to evaluate whether their payout rate makes sense for their circumstances.
Under UPMIFA, anyone managing or investing an institutional fund must act in good faith and use the care an ordinarily prudent person in a similar position would use. Investment and spending decisions must weigh general economic conditions, inflation and deflation, expected total return, the fund’s duration and purpose, the institution’s other resources, and its overall investment policy. UPMIFA also requires diversification unless the fund’s purposes are better served without it, and individual investment decisions must be judged in the context of the whole portfolio.
An endowment goes “underwater” when its market value drops below the original gift amount, such as a $1,000,000 gift shrinking to $850,000 in a downturn. Older law often barred any distributions from underwater funds. UPMIFA allows continued spending if it is prudent after weighing the same factors above, provided managers document their reasoning and confirm the payout does not threaten the fund’s long-term survival.
When Endowment Terms Need to Change
Sometimes a donor’s original purpose becomes impossible or impractical. A fund may have been created to support a department that no longer exists, or a population the institution no longer serves. Courts can then apply the cy pres doctrine — a legal principle meaning “as near as possible” — to redirect the funds toward a purpose closely matching the donor’s original intent. Rather than invalidating the gift, a court selects a new use that honors its spirit.
Well-drafted gift instruments often anticipate this by including a cy pres provision, which gives the institution authority to modify restrictions when circumstances change. Without one, the institution generally has to petition a court for permission to redirect the funds, which can be slow and expensive. Flexible language in the original gift agreement protects both the donor’s broader charitable goals and the institution’s ability to keep putting the money to work.