What is a Restricted Fund
A restricted fund is a reserve of money that can only be used for specific purposes. Restricted funds provide reassurance to donors that their contributions are used in a manner they have chosen. When a donor gives money to a nonprofit organization, he or she may specify whether the gift is unrestricted and can be used for any purpose the organization sees fit. If the funds are temporarily restricted, they must be used for a specific purpose. With permanently restricted funds, the donation acts as principal on which interest can be earned (and only the interest is to be spent).
BREAKING DOWN Restricted Fund
If a donor restricts a nonprofit organization to allocate their restricted funds to a specific purpose, it is required to do so by law. Failure to comply may result in the donor taking legal action and reporting the nonprofit to the Office of the Attorney General. Usually, endowments are considered restricted funds. Their principal usually cannot be spent, and only a specified percent of the interest they earn can be spent per year. Furthermore, there are restrictions on how the interest can be spent. For example, it may be used only to fund scholarships and professorships. (For more, see: How do University Endowments Work?)
Designation of a Restricted Fund
The donor determines if the funds are to be restricted. Typically, fund designation is specified in writing or through an understood agreement with the nonprofit. Foundations that provide restricted funds often describe how they want their money allocated when they distribute the award. Nonprofit organizations can avoid confusion about how they intend to spend a donor’s funds by offering a choice of designation. For example, a cancer research nonprofit could give donors a choice to allocate their funds to either breast, skin or brain cancer clinical trials.
Restricted Fund Management for Nonprofit Organizations
Typically, restricted funds are not required to be placed into a segregated bank account, but must be accounted for separately in a nonprofit’s financial statements. When budgeting, nonprofits should separate restricted and unrestricted funds so that they allocate the money they have to spend correctly. For example, if $100,000 is budgeted for restricted funds, it cannot be mistakenly spent for unrestricted purposes.
Nonprofit organizations could implement an internal system that alerts management when restricted fund obligations have been met; once the donor’s wishes are satisfied, excess money can be transferred to unrestricted funds. Nonprofit employees should be trained to identify expenditures that require allocation to restricted funds. Staff correctly allocating money keeps donors satisfied and helps avoid legal disputes.