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Understanding restricted funds and endowments for charities

Most donations to charities bequeathed in a will are made without specific conditions regarding their use, meaning that the funds can be used by the charity in any way that furthers its charitable purposes. However, some donations come with specific conditions, creating what are known as restricted funds.

What are restricted funds?

A restricted fund is created when assets are left to a charity on binding terms that restrict how such assets may be utilised. For instance, if a donor’s legacy is made subject to an obligation on the charity to use it to fund a specific project or to establish a scholarship in their memory.

The role of endowment funds

Restricted funds often take the form of endowment funds, which are funds given to a charity to be held as capital for a number of years, often in perpetuity.

The charity trustees are required to either:

• invest the asset; or
• retain and use it for the charity’s purposes.

The terms of a permanent endowment may permit assets to be sold and reinvested, or may provide that the assets, such as a particular building, are retained indefinitely.

The usual position is that charity trustees are permitted to spend any interest generated by the fund, but not the capital itself. Where charity trustees have power to convert all or part of an endowment into income, such assets are known as expendable endowment.

Permanent endowments

A permanent endowment can be either:

• Investment permanent endowment – namely a fund of assets that must be invested to produce income to be used for the fund’s purposes; or
• Functional permanent endowment – property (often land) that must be used for a specific purpose or purposes of a charity but may not produce an income, sometimes referred to as “designated land”. An example of the latter is a recreational sports ground for the benefit of the inhabitants of a village.

Why do donors choose endowments?

Many donors wish to establish their funds as an endowment since it ensures that the fund continues in existence and can provide a benefit in future years. Moreover, provided the terms of the legacy are worded and applied correctly, and the recipient is a charity for tax purposes, the donation will be exempt from inheritance tax.

It is therefore pivotal for the donor to ensure that they are clear in setting out their conditions for the fund within their will. However, it is the case that a legacy may sometimes appear restricted or non-expendable upon first glance, but closer examination will reveal that it is in fact not; these are matters that we recommend a charity obtains legal advice on in order to ensure that the trustees fulfil the true intentions of the donor when administering the fund.

There may be a change of circumstances in the future which mean that the donor’s original intentions are no longer relevant, which will warrant the variation or removal of the existing restrictions on the fund. In such circumstances, we are able to advise and assist the charity accordingly, perhaps by applying for permission from the Charity Commission to expand or amend the terms of the fund.

Making the most of restricted gifts

To ensure your charity is managing restricted funds effectively it’s important to regularly review and reflect on your approach. Consider the following:

• Review existing funds: Assess any restricted or endowment funds your charity holds. Are the terms clearly documented, and are you confident that the funds are being used in accordance with those terms?
• Clarify ambiguities: If the wording of a legacy or fund is unclear, seek legal advice to avoid inadvertently breaching restrictions or misinterpreting the donor’s intentions.
• Plan for the future: Consider how your charity can continue to honour long-term funds while remaining responsive to changing circumstances. Does your current approach allow for flexibility, sustainability, and compliance?

How we can help

We specialise in advising charities and not-for-profit organisations on legacy management and the structuring and administration of restricted and endowment funds. Whether you’re interpreting the terms of a legacy, seeking Charity Commission consent to amend fund restrictions, or advising a potential donor on setting up a lasting gift – we’re here to help.