A restricted fund is a set-aside account that holds money that can only be used for specific purposes. Restricted funds assure donors that their contributions will be used as they have chosen. They most often appear as part of funds held by certain nonprofit organizations, universities, or insurance companies.
What is a Restricted Fund?
A restricted fund contains money designated by a donor and can only be used for a specific purpose. Any surplus can become unrestricted once the goal is reached if the money is temporarily restricted. If the money is permanently restricted, it must be kept intact as an endowment, usually in perpetuity, and only the interest earned on the investment of the gift can be spent to serve the purpose.
Types of Restricted funds for Nonprofits
When a donor donates money to a nonprofit, they can specify how a donation will be used in three basic ways:
Unrestricted funds: The money in it can be used for any purpose the organization deems appropriate.
Temporarily Restricted Funds: Money must be used for a specific purpose.
Permanent Restricted Fund: In this case, the donation is designed to be held in perpetuity as principal, from which interest can be earned, and only interest can be spent.
If a donor prevents a nonprofit from allocating funds for a specific purpose, the law requires them to do so. Failure to do so can result in the donor being sued and the nonprofit being reported to the Attorney General's office.
Donations are generally permanently restricted funds. In most cases, the principal cannot be spent, and only a certain percentage of the interest you earn each year can be spent. There are also restrictions on how interest can be spent. A scholarship to a university, for example, may be restricted to funding scholarships and professorships.
A restricted donor fund for a nonprofit organization typically designates what the money can be used for in a written document called a "gift instrument."
How are restricted funds designated?
The donor determines if the funds will be restricted. The designation of the fund is usually specified in writing on what is called a "gift instrument." Foundations that offer restricted funding often outline how they want their money distributed when distributing the awards.
Nonprofits can avoid confusion about how they intend to spend donor funds by offering a designation option. A nonprofit cancer research organization, for example, may offer donors the opportunity to allocate funds for any clinical study of breast, skin, or brain cancer.
Restricted fund management for nonprofit organizations
In general, restricted funds should not be placed in a separate bank account but should be accounted for separately in a nonprofit organization's financial statements. When budgeting, nonprofits need to separate restricted and unrestricted funds in order to properly allocate the money they need to spend. They can set up an internal system that notifies management when the fund's restricted obligations have been met. Once the donor's wishes are granted, any excess money can be transferred to unrestricted funds.
Nonprofit employees should be trained to identify expenses that require restricted funding. When employees allocate money correctly, they make donors happy and help avoid disputes.
Do restricted funds require their own bank accounts?
No. You don't have to separate the money when putting it into the account. Instead, the separation should be handled by the nonprofit's balance sheet accounting practices.
What happens if restricted funds are spent for non-designated purposes?
Funds are restricted by law, so a donor can take legal action and demand their return if they are not used for their purpose. The donor can also report the nonprofit to the attorney general's office.
Summary
A restricted fund is any cash balance that has been set aside for a specific or restricted use.
Restricted funds, often combined with funds held for donations to nonprofit organizations or grants, ensure that donors are the only ones who can direct the use of these assets.
Violation of restrictions or unauthorized use of restricted funds may result in legal action.
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