Endowments come in three types: true (permanent) endowments, term endowments, and quasi (board-designated) endowments. What separates them is who sets the restrictions on the principal, how long those restrictions last, and whether the institution can ever spend the underlying gift. A true endowment locks the principal away forever at the donor’s direction. A term endowment carries donor restrictions that expire on a date or after a specific event. A quasi endowment has no donor restriction at all — the institution’s own board chooses to treat unrestricted money as if it were endowed, and can undo that choice whenever it wants.
True (Permanent) Endowments
A true endowment is a donor-restricted gift where the original principal must be preserved indefinitely. The IRS defines a permanent endowment as funds “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 named scholarship, only the investment returns can be spent. The million dollars itself stays invested, regardless of how badly the institution might want to use it.
The donor’s terms usually live in a written gift instrument, which functions as a binding agreement between the donor and the receiving organization. It sets out the purpose of the fund — a professorship, a research program, a scholarship — and the institution is legally obligated to honor those terms. On the balance sheet, the principal is reported as net assets with donor restrictions, which signals that the money cannot be repurposed.
Because the restrictions never lapse, the consequences of ignoring them are serious. State attorneys general have authority to intervene when charitable assets are misused, and institutions that violate donor restrictions can be sued.
Term Endowments
A term endowment carries donor-imposed restrictions that end after a set period or when a specific event happens. The IRS describes them 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 opens. When the term ends, the institution can spend the principal outright along with any remaining earnings.
While the restriction is in force, a term endowment behaves like a true endowment: the principal is invested, and only the returns fund the donor’s stated purpose. Financial statements report these funds as temporarily restricted. Once the trigger occurs, the balance moves to unrestricted status.
This structure suits donors who want their gift to compound through long-term investing but also want the institution to eventually gain full access to the capital. Someone funding a 15-year research initiative might set the term to match, so the fund generates steady income during the active work and then releases whatever’s left when the project ends.
Quasi (Board-Designated) Endowments
Quasi endowments — also called board-designated endowments or funds functioning as endowments — are structurally different from the other two because no donor restriction exists. The institution’s governing board voluntarily earmarks unrestricted money to be invested and managed like an endowment. The IRS treats 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 nothing outside the institution binds the money, the board can reverse itself and spend the principal whenever it decides to. A board might set up a quasi endowment in a strong year, investing surplus funds for long-term income. If a disaster hits campus or revenue drops off a cliff, the same board can vote to un-designate the funds and use them right away. That flexibility is the whole point. A quasi endowment is a financial planning tool, not a legal obligation.
Creating or unwinding a quasi endowment normally takes a formal board resolution. The resolution typically states the amount being designated, the intended purpose, the investment and spending policies, and — importantly — the board’s continuing authority to modify or terminate the designation.
The Three Types at a Glance
- True (permanent) endowment. Donor-restricted. Principal preserved forever. Only investment returns are spendable.
- Term endowment. Donor-restricted for a set period or until a specific event. Principal becomes fully spendable when the term ends.
- Quasi (board-designated) endowment. No donor restriction. Board designates unrestricted funds and can reverse the designation at any time.
How Endowments Actually Spend Money
An endowment isn’t a savings account. The funds are invested across a diversified portfolio of stocks, bonds, real estate, and other assets, and the institution distributes a set percentage of the fund’s value each year. Most annual payouts run between roughly 4% and 5.5% of market value, though the exact rate depends on investment performance and internal policy.
The rate is deliberately conservative. If the portfolio averages a 7% to 8% annual return but only 5% is paid out, the balance stays invested. That reinvestment is what lets the fund keep pace with inflation and survive future downturns. Spending aggressively in good years leaves less cushion when markets fall; spending too little starves the institution of resources it could use now.
Legal standards matter here too. The Uniform Prudent Management of Institutional Funds Act (UPMIFA), adopted in some form by 49 states, is the primary framework governing endowment management. In states that adopted the optional provision, spending more than 7% of a fund’s value in a single year creates a rebuttable presumption of imprudence. The fund’s value for that calculation is generally an average of quarterly valuations over at least three years, which smooths out short-term swings. Spending under 7% isn’t automatically prudent — institutions still have to weigh factors like general economic conditions, inflation, expected total return, the fund’s duration and purpose, other resources available to the organization, and the institution’s investment policy.
Underwater Endowments
An endowment goes “underwater” when its market value falls below the original gift amount, such as a $1,000,000 gift that drops to $850,000 in a downturn. Under older law, many institutions couldn’t distribute anything from an underwater fund. UPMIFA lets institutions keep spending from underwater endowments if the distribution is prudent under the same factors listed above, with the reasoning documented.
When Endowment Terms Have to Change
Sometimes the original purpose of a restricted endowment stops making sense. The department the donor named no longer exists. The population the fund was meant to serve is no longer part of the institution’s mission. In those situations, courts can apply the cy pres doctrine, a legal principle meaning “as near as possible,” to redirect the fund to a purpose that closely matches the donor’s original intent. The gift isn’t invalidated; the court picks a new use that fits the spirit of the original.
Many gift instruments plan for this by including a cy pres provision that lets the institution modify restrictions when circumstances change. Without one, the organization typically has to petition a court, which takes time and money. This is worth knowing if you’re comparing the three types: donor restrictions on true and term endowments are strong, but they aren’t absolutely unbreakable when the purpose itself becomes impossible.