An endowment is a pool of donated assets that a nonprofit invests for the long term, spending only a portion of the earnings each year while keeping the original gift largely intact. The structure turns a one-time donation into a lasting source of funding: the principal generates investment returns, and those returns pay for scholarships, research, operations, or grants year after year. Universities, museums, hospitals, and foundations all use endowments to smooth out ups and downs in annual giving and to fund commitments that stretch across generations.
The Two Layers: Principal and Income
Every endowment has two financial layers. The principal, sometimes called the corpus, is the original donated amount. The nonprofit invests it across stocks, bonds, real estate, and other asset classes, aiming to grow the balance faster than inflation over time.
The investment income — dividends, interest, and realized gains — is the cash the organization actually spends. By drawing only from earnings and leaving the principal alone, the institution preserves the fund’s purchasing power. A scholarship funded by an endowment today should deliver roughly the same real value to a student fifty years from now.
The Three Types of Endowments
Endowments fall into three categories, distinguished by who sets the spending restrictions and how long those restrictions last. The IRS uses the same three categories for federal reporting, and nonprofits must report the percentage of their total endowment held in each type on Schedule D of Form 990.1IRS.gov. Instructions for Schedule D (Form 990)
A permanent endowment is one where the donor legally requires the principal to stay invested in perpetuity. Only the income the fund generates may be spent. This is the most restrictive type and the one most people picture when they hear the word “endowment.”
A term endowment restricts spending of the principal for a set number of years or until a specific event occurs. Once that milestone passes, the organization may spend the principal too.
A quasi-endowment, also called a board-designated endowment, is created when an organization’s own governing board decides to treat a pool of unrestricted funds as if it were an endowment. Because no donor restriction exists, the board can reverse the designation and spend the principal whenever it chooses.
Who Holds Endowments
A wide range of nonprofits rely on endowments for financial stability. Universities and colleges are the most visible example, using endowment income to fund scholarships, endowed faculty chairs, and research programs. Museums, libraries, and other cultural institutions use endowments to care for permanent collections. Hospitals manage endowment funds to support medical research and subsidize care for uninsured patients. Large charitable foundations draw on endowment capital to issue annual grants to smaller community organizations.
For all of these entities, the endowment acts as a financial buffer. When annual donations dip or government funding declines, the endowment’s steady income lets the organization keep operating without drastic cuts. Most institutions set a minimum gift size — often $50,000 or more — before they will establish a separately named endowment fund, because smaller amounts generate too little annual income to justify tracking them independently.
How Spending Is Decided
The primary law governing endowment management is the Uniform Prudent Management of Institutional Funds Act (UPMIFA), adopted in 49 states and the District of Columbia. Pennsylvania has its own separate statute covering the same ground. UPMIFA sets fiduciary standards for board members and rules for investing, spending, and modifying endowment funds.
Board members owe a duty of loyalty and care. They must invest in good faith, using the care a reasonably prudent person in a similar position would exercise, diversify to reduce the risk of large losses, and weigh both current income needs and long-term preservation of value.
The Seven Prudence Factors
When deciding how much to spend from an endowment in a given year, UPMIFA requires the governing board to weigh seven specific factors:
- The duration of the fund and any donor intent regarding its time horizon
- The charitable purpose of the institution and the fund
- General economic conditions
- The potential effects of inflation or deflation
- The expected total return from the endowment’s investments
- The institution’s other financial resources and anticipated needs
- The institution’s investment policy and asset allocation
These factors work together to prevent boards from spending too aggressively during strong markets or cutting too deeply during downturns. UPMIFA also creates a rebuttable presumption that spending more than seven percent of a fund’s fair market value in a single year is imprudent.
Typical Spending Rates
Most institutions set a formal spending rate — the percentage of the endowment’s market value that may be withdrawn each year for operations. That rate typically falls between four and five percent of the fund’s total value. To avoid sharp swings when markets are volatile, many organizations calculate the payout based on a three-year rolling average of the endowment’s value rather than a single year-end snapshot.
Over the long run, institutions generally target total investment returns of roughly seven to eight percent, enough to cover the four-to-five-percent distribution, offset inflation, and let the principal grow gradually.
Underwater Endowments
An endowment is called “underwater” when its current market value drops below the original gift amount. A $1 million gift whose investments have declined to $850,000 is one example. Under UPMIFA, the institution may still spend from an underwater fund, but the board must carefully document its reasoning under the seven prudence factors. This replaced an older rule that flatly prohibited spending below the original gift value.
Changing a Donor’s Original Restrictions
When a donor’s original instructions become outdated or impossible to follow, such as a fund restricted to a department the university has since closed, UPMIFA provides a path to modify the restriction. If the donor is still alive and willing, the institution can work directly with the donor to release or change the terms. When the donor is unavailable, the institution may petition a court under the equitable doctrine known as cy pres.
A court may approve a modification when the original purpose has become unlawful, impracticable, impossible, or wasteful. Before the court acts, the state attorney general must receive notice and be given an opportunity to weigh in. With the attorney general’s agreement, the matter can often be resolved through a streamlined consent decree rather than a full trial.
Private Foundations Play by Different Rules
Private foundations that hold endowment-like assets face federal requirements that public charities do not. Unlike public charities, which set their own spending policies within UPMIFA, private foundations must distribute at least five percent of the fair market value of their investment assets each year for charitable purposes. The five-percent figure includes both grants paid to other organizations and the foundation’s own eligible operating expenses. Falling short triggers a 30-percent excise tax on the undistributed amount, and an uncorrected shortfall can trigger an additional 100-percent tax.2Office of the Law Revision Counsel. 26 USC 4942 – Taxes on Failure to Distribute Income
Private foundations also owe an annual excise tax of 1.39 percent on their net investment income — interest, dividends, rents, royalties, and capital gains — regardless of how much they distribute.3Office of the Law Revision Counsel. 26 USC 4940 – Excise Tax Based on Investment Income
Tax Benefits for Donors
Contributing to a nonprofit’s endowment can produce meaningful tax benefits, though the rules depend on what you give and how much you earn.
Cash contributions to a public charity’s endowment are deductible up to 60 percent of your adjusted gross income for the tax year. Donations of appreciated long-term capital-gain property, such as stock held for more than a year, are deductible up to 30 percent of AGI.4Office of the Law Revision Counsel. 26 US Code 170 – Charitable, Etc., Contributions and Gifts Contributions exceeding these limits can be carried forward for up to five additional tax years.
Starting in the 2026 tax year, a new floor applies: you may only deduct charitable contributions to the extent they exceed 0.5 percent of your adjusted gross income. For someone with $200,000 in AGI, the first $1,000 in charitable giving produces no deduction. Top-bracket taxpayers also face a cap that limits the tax benefit of all itemized deductions, including charitable gifts, to roughly 35 percent of the value given.
Donating appreciated stock directly is one of the most tax-efficient ways to fund an endowment. You receive a deduction for the full fair market value and avoid paying capital gains tax on the appreciation. If donated property other than cash or publicly traded securities is worth more than $5,000, you must obtain a qualified appraisal and attach IRS Form 8283 to your tax return.5Internal Revenue Service. Charitable Organizations – Substantiating Noncash Contributions
If you are at least 70½ years old, you can make a qualified charitable distribution directly from a traditional IRA to an eligible charity’s endowment. The 2026 annual limit is $111,000 per individual.6Internal Revenue Service. 2026 Amounts Relating to Retirement Plans and IRAs A QCD counts toward your required minimum distribution but is excluded from your taxable income, which is especially valuable for retirees who do not itemize deductions.