In law, an endowment is a pool of donated assets that a nonprofit holds and invests on a long-term basis, spending only a portion of the returns each year to fund its mission. The principal is preserved; the earnings do the work. What separates an endowment from an ordinary charitable gift is the legal restriction on the principal itself, usually imposed by the donor and enforced under state law. Universities, hospitals, museums, and community foundations rely on this structure because it turns a single gift into a permanent funding stream, and because state statutes give the arrangement teeth.
Principal, Earnings, and the Spending Policy
Every endowment has two moving parts: the principal (sometimes called the corpus) and the investment earnings that principal generates. The principal is the original donated amount, and preserving it is the entire point. Interest, dividends, and capital gains from investing the principal fund the institution’s operations each year. The tension in running an endowment is pulling enough out annually to be useful while leaving enough invested to keep pace with inflation.
Institutions manage that tension through a spending policy, which sets the dollar amount or percentage the organization can withdraw each year. Most endowments apply a fixed spending rate to a rolling average of the fund’s market value over the prior three to five years. Averaging across multiple years smooths out market swings so a single bad year doesn’t force immediate budget cuts.
Typical spending rates fall between roughly 4% and 5%. In fiscal year 2025, the average effective spending rate among U.S. higher education endowments was 4.9%, up from 4.8% the year before and 4.6% in fiscal year 2023.1NACUBO. U.S. Higher Education Endowments Report Stable Returns, Increase Spending to $33.4 Billion in FY25 A rate in that band is designed to cover distributions and administrative costs while leaving enough invested to outpace inflation over time.
UPMIFA: The Governing Law
The Uniform Prudent Management of Institutional Funds Act, known as UPMIFA, provides the legal framework for how nonprofits invest and spend endowment funds. It has been adopted in 49 states. UPMIFA replaced an older law that rigidly required institutions to preserve the exact dollar amount of the original gift. In its place, UPMIFA imposes a prudent-person standard that asks managers to weigh several factors before deciding how much to spend:
- The fund’s duration and purpose
- General economic conditions
- The possible effect of inflation or deflation
- The expected total return from income and appreciation of investments
- Other resources of the institution
- The institution’s investment policy
Some states adopted an optional provision creating a rebuttable presumption of imprudence if an institution spends more than 7% of a fund’s fair market value, calculated as an average over the preceding three years. Spending above 7% is not automatically unlawful, but the burden shifts to the institution to prove the spending was reasonable. Most well-managed endowments stay well below that line.
Nonprofits report their endowment activity to the IRS on Form 990, Schedule D, Part V, disclosing contributions received, investment earnings, grants distributed, and administrative expenses for each of the five most recent fiscal years.2Internal Revenue Service. Instructions for Schedule D (Form 990)
The Three Types of Endowments
Not all endowments carry the same legal restrictions. The differences come down to who controls the principal and whether it can ever be spent.
Permanent (true) endowments. The donor stipulates that the principal must remain intact forever. Only investment earnings can be spent. These are the most restrictive form and typically make up the majority of a large institution’s endowment portfolio.
Term endowments. The donor restricts the principal for a set period or until a specific event occurs. Once the clock runs out or the condition is met, the remaining principal becomes available for spending on a designated purpose or general operations.
Quasi-endowments (funds functioning as endowments). No donor restriction exists on the principal. The institution’s own governing board sets aside unrestricted funds and invests them as though they were a permanent endowment. Because the restriction is self-imposed, the board can vote to spend the principal whenever it chooses.
The distinction matters for compliance. Permanent and term endowments carry donor restrictions that bind the institution under UPMIFA and state law. Quasi-endowments, being board-designated, follow the institution’s internal policies rather than legally enforceable donor restrictions. In higher education, true endowments commonly account for over half of total endowment assets.
How Donor Intent Gets Established: The Gift Instrument
Donor intent for permanent and term endowments is established through a gift instrument. Under UPMIFA that term is defined broadly. It can be a will, a deed, a grant agreement, a letter, an email, or an institutional solicitation. That last category catches organizations off guard. If a fundraising brochure invites gifts “to our scholarship endowment,” contributions received in response are treated as true endowment funds subject to UPMIFA, even if the donor never used the word endowment in their own reply. The solicitation itself becomes part of the record of donor intent.
Underwater Endowments
An endowment is underwater when its current market value drops below the original gift amount. Under the older law that preceded UPMIFA, an underwater fund was effectively frozen: the institution had to stop applying its spending rate and could spend only interest and dividend income until the market value recovered. That left organizations cutting programs precisely when they were most needed.
UPMIFA changed that. An institution may continue applying its spending rate to an underwater fund, provided the spending is prudent after weighing the same factors that govern all endowment spending decisions. Prudence is judged at the time the decision is made, not in hindsight if the market drops further afterward.
Fiduciary Duties and Consequences of Mismanagement
Managing an endowment is a fiduciary responsibility, typically carried out by the institution’s board of trustees or a dedicated investment committee. The committee sets the investment policy statement, which specifies asset allocation targets, risk tolerance, and performance benchmarks. The investment policy has to line up with the spending policy and the institution’s long-term financial needs.
The core financial job is achieving a total return that covers three drains on the fund: the annual spending distribution, administrative fees, and inflation. Falling short of that combined target consistently means the endowment loses purchasing power over time, so future generations get less support than current ones. Preserving that balance across generations is sometimes called generational equity.
Mismanagement carries real legal consequences. State attorneys general have enforcement authority over charitable funds and can bring breach-of-trust actions against institutions that divert endowment money from its intended purpose or fail to invest prudently. Remedies include recovery of lost funds plus interest, removal of directors and officers, civil penalties, and, in extreme cases, involuntary dissolution of the organization. Individual board members can be held personally liable if a loss results from their failure to exercise due care or loyalty.
Self-dealing is treated especially harshly. When a director profits from a transaction involving charitable assets, enforcement actions can seek recovery of the profit, actual damages, and sometimes punitive damages, along with permanent removal of the director. Even well-intentioned boards can face liability for weak internal controls that allow misappropriation, waste, or misuse of restricted endowment funds.
Tax Rules for Donors and Institutions
Gifts to qualified 501(c)(3) organizations, including endowment contributions, are deductible on federal income taxes for donors who itemize. Deduction limits depend on what you give and what kind of organization receives it.
For cash gifts to public charities such as universities and hospitals, you can deduct up to 60% of your adjusted gross income in the year of the gift. For donations of long-term appreciated assets such as stock held more than a year, the limit is 30% of AGI, but you can deduct the full fair market value without paying capital gains tax on the appreciation. If contributions in a given year exceed the applicable AGI limit, the excess can be carried forward and deducted over the next five years.3Internal Revenue Service. Publication 526, Charitable Contributions
Two 2026 changes are worth flagging for endowment donors. Itemized charitable deductions now apply only to the extent contributions exceed 0.5% of adjusted gross income. On a $400,000 AGI, the first $2,000 in donations generates no deduction. And for taxpayers in the 37% marginal bracket, the tax benefit of charitable deductions is capped at 35%.
The Excise Tax on Large University Endowments
Since 2017, certain private colleges and universities have faced a federal excise tax on their endowment investment income. The tax applies to institutions that enroll at least 500 students and hold endowment assets exceeding $500,000 per student, after excluding assets used directly for educational purposes. Qualifying institutions pay 1.4% of net investment income annually. The $500,000-per-student threshold is not adjusted for inflation, so more institutions cross it as endowments grow. Only a relatively small number of wealthy private schools currently owe this tax.