An endowment fund is a pool of donated money or property that a nonprofit — a university, hospital, museum, or charitable foundation — invests permanently so the gift keeps generating income year after year. The original principal, called the corpus, stays invested. Only a slice of the returns is spent each year, usually around four to five percent of the fund’s average value. That structure lets the organization support scholarships, research, or operations indefinitely, and it’s shaped by state fiduciary law, federal tax rules, and specific financial reporting standards.
The institution holding the fund is a fiduciary. It has to manage the money responsibly, honor the donor’s instructions, and put the fund’s long-term health ahead of short-term spending pressure. The endowment is also accounted for separately from the general operating budget, which keeps the organization from draining it to cover payroll or emergencies.
The Three Types of Endowment Funds
Endowments fall into three categories depending on who imposed the restrictions and how firm they are. The category controls how much flexibility the organization has.
A permanent endowment, sometimes called a donor-restricted endowment, is created by a written gift agreement that requires the principal to stay invested in perpetuity. Only the income can be spent, and the donor can narrow that further — for example, limiting distributions to scholarships in a particular department. These carry the strongest legal protections, and the state attorney general can step in if the terms are violated.
A term endowment works the same way but only for a set period or until a specific event occurs. Once the term ends, the organization can spend what remains according to the gift agreement.
A board-designated endowment, also called a quasi-endowment, is money the organization’s own board has decided to treat like an endowment. No outside donor restriction applies. The board can reverse the designation and spend the principal whenever it chooses.
For federal reporting, permanent and term endowments are classified as net assets with donor restrictions. Board-designated endowments are net assets without donor restrictions. The breakdown among the three types has to be reported on IRS Form 990, Schedule D, and the three percentages must add up to 100 percent.1IRS.gov. Instructions for Schedule D (Form 990)
How Much Can Be Spent Each Year
Most endowments distribute between four and five percent of the fund’s fair market value each year. To avoid wild swings in payouts, institutions typically calculate the spending amount using a rolling three- to five-year average of the fund’s value. A single bad year doesn’t gut ongoing programs, and a single great year doesn’t lock in spending the fund can’t sustain later.
The donor’s instructions come first. A gift agreement can set exact spending limits, confine distributions to specific programs, or require part of the earnings to be reinvested. When the gift agreement is silent, the board sets the rate, subject to the prudence rules described below. Some states add a rebuttable presumption that spending more than seven percent in a year is imprudent.
Inflation quietly eats away at purchasing power. If a fund distributes five percent and only matches inflation, its real value shrinks each year. Many institutions track specialized measures like the Higher Education Price Index, which rose 3.6 percent in fiscal year 2025, to set return targets that preserve the fund’s buying power over time.
Institutions also commonly charge the endowment an annual administrative fee, a modest percentage of market value, deducted from returns before spending is calculated. Whether and how that fee can be charged is sometimes addressed in the gift agreement itself.
The Prudence Rules That Govern Investing and Spending
Nearly every state follows the Uniform Prudent Management of Institutional Funds Act, known as UPMIFA. It’s the backbone of endowment law in the United States. Instead of locking spending to the original dollar value of each gift, UPMIFA tells managers to make decisions based on overall prudence — acting in good faith with the care a reasonably careful person in the same position would use.
When deciding how much to spend or accumulate, the institution has to weigh seven factors:
- The duration and preservation of the fund
- The purposes of the organization and the specific fund
- General economic conditions
- The possible effect of inflation or deflation
- The expected total return from income and appreciation
- Other resources available to the institution
- The institution’s investment policy
The same factors govern investing. UPMIFA applies modern portfolio theory: an investment is judged by how it fits inside the overall portfolio, not in isolation. Diversification is an express requirement. Managers also owe two core duties — loyalty, meaning decisions serve the mission rather than any individual’s interests, and care, meaning the diligence a careful person would use. The law doesn’t bar mission-aligned investing, but any such holding still has to clear the prudence standard and fit a diversified portfolio.
Spending From Underwater Funds
An endowment is “underwater” when its current market value drops below the original gift amount. Under the older law, institutions generally couldn’t spend from these funds at all. UPMIFA allows continued spending if the institution determines it’s prudent after weighing the same seven factors, in good faith, with documented reasoning. The aggregate deficiency has to be disclosed in financial statements.
Modifying Donor Restrictions
Endowments are built to last indefinitely, but circumstances shift. A scholarship tied to a program that no longer exists, or a research fund earmarked for a cured disease, may become impossible to administer as written. UPMIFA gives institutions two paths. They can ask the donor, in writing, to agree to a change. If the donor is unavailable or won’t agree, the institution can petition a court to redirect the fund under the doctrine of cy pres — meaning “as near as possible” to the original intent. Courts approve such changes when the original purpose has become unlawful, impossible, or impracticable. The state attorney general has to be notified and gets a chance to weigh in on behalf of the public.
Delegating Investment Management
Most institutions don’t manage endowment portfolios entirely in-house. UPMIFA allows delegation to outside investment offices, advisors, and fund managers, as long as the institution exercises reasonable care in selecting the agent, setting the scope of the delegation, and reviewing performance periodically. An institution that follows those steps generally isn’t liable for the agent’s individual investment decisions. The outside agent, in turn, has to act within the delegation and is subject to the state’s courts for any disputes.
Advisor fees typically run from 0.25 to 2.00 percent of assets under management, depending on fund size and strategy. UPMIFA imposes an express cost-management duty: fees have to be reasonable for the services provided. Excessive fees cut into the mission and can themselves be a breach of fiduciary duty.
Taxes on Endowment Income
Endowment investment income generally escapes federal income tax because the holding institution is tax-exempt. Dividends, interest, royalties, and capital gains from endowment investments are specifically excluded from unrelated business taxable income under the Internal Revenue Code.2Office of the Law Revision Counsel. 26 U.S. Code 512 – Unrelated Business Taxable Income If the endowment generates income from an active trade or business unrelated to the institution’s exempt purpose — operating a commercial restaurant open to the public, for instance — that income can be subject to unrelated business income tax.
A separate excise tax hits certain large private colleges and universities. Under Section 4968 of the Internal Revenue Code, a private institution is subject to the tax if it enrolls at least 3,000 tuition-paying students, more than half of them in the United States, and holds endowment assets of at least $500,000 per student. The rate is tiered by per-student endowment size:3Office of the Law Revision Counsel. 26 USC 4968 – Excise Tax Based on Investment Income of Private Colleges and Universities
- 1.4 percent of net investment income for a per-student endowment between $500,000 and $750,000
- 4 percent between $750,000 and $2,000,000
- 8 percent above $2,000,000
Assets used directly for the institution’s exempt purpose, such as campus buildings and equipment, are left out of the per-student calculation. State colleges and universities are not subject to this excise tax.
Reporting Requirements
Nonprofits holding endowments face reporting duties on two tracks. The Financial Accounting Standards Board requires balance sheets to present two categories of net assets: with donor restrictions and without.4Financial Accounting Standards Board. Accounting Standards Update No. 2016-14 – Presentation of Financial Statements of Not-for-Profit Entities Donor-restricted endowments sit in the first; board-designated endowments sit in the second. The two-class system replaced an older three-category framework and gives readers a clearer sense of how much of an institution’s wealth is legally committed.
When funds are underwater, the institution has to disclose the aggregate fair value of all underwater funds, the original gift amounts that must be maintained, the total deficiency, and the board’s policy on whether spending continued during the period.
On the tax side, any organization that reports holding endowment funds on Form 990 completes Part V of Schedule D. That section covers beginning and ending balances, contributions received, investment gains and losses, distributions for grants and programs, and administrative expenses, broken out for the current and prior year, along with the percentage of total endowment held in each of the three fund types.1IRS.gov. Instructions for Schedule D (Form 990)
Who Enforces the Rules
State attorneys general are the primary enforcement authority for charitable endowments. Under longstanding law reinforced by UPMIFA, the attorney general represents the public’s interest in making sure donated funds are used as intended. If an institution invests or spends imprudently, diverts restricted funds, or otherwise mismanages an endowment, the attorney general can sue.
Available remedies include requiring a detailed accounting, enjoining improper spending, ordering the return of misspent funds, removing fiduciaries who breached their duties, and in extreme cases requesting the appointment of a new trustee. Donors themselves generally cannot sue to enforce the terms of a charitable gift. That authority rests with the attorney general, acting on behalf of the public as the ultimate beneficiary.
Investment advisors managing endowment assets face separate consequences for misconduct. The Securities and Exchange Commission can bring enforcement actions against registered advisors who breach their fiduciary duties, such as overcharging fees or hiding conflicts of interest. Penalties can include disgorgement of improperly charged fees, civil fines, and cease-and-desist orders. Board members themselves may face personal liability for losses tied to their own negligence in overseeing the fund.