Restricted vs. Unrestricted Gifts

Published by Instant Press on behalf of Fight For A Living Wage.

A restricted gift can only be spent on the purpose you name. An unrestricted gift goes into general operations, where the organization decides how to use it. That single difference drives most of what donors find confusing about nonprofit finances, including why a group with money in the bank can still be unable to pay its staff, and why the organizations doing the steadiest work tend to ask for the kind of gift that sounds least impressive.

What a restriction is

A donor restriction is a condition attached to a gift at the time it is made. Once accepted, it binds the organization. Spending a restricted gift on something else is not a judgment call, it is a misuse of funds, and it can require the organization to repay the amount from unrestricted reserves.

Accounting standards split restrictions into two kinds. Net assets with donor restrictions covers gifts limited by purpose or by time, including multi-year pledges that release in installments. Net assets without donor restrictions covers everything the board can direct. You will see both lines on an audited statement of financial position.

Worth distinguishing from both: board-designated funds. Those look restricted and are not. The board set them aside and the board can unset them. A reserve described as designated carries no donor condition, which matters if you are reading a balance sheet to judge flexibility.

Why donors restrict

The instinct is reasonable. You care about one program, you want your money in that program, and a restriction gives you a traceable line from your gift to a specific activity. For large gifts, restriction also creates accountability, since the organization has to report against the stated purpose.

Funders with a defined mandate often have no choice. A foundation chartered to support early childhood education cannot write an unrestricted check to a group that also runs a food program.

Why organizations ask for the other kind

Restricted funding covers program costs and typically underfunds the things that make programs possible. Rent, accounting, insurance, payroll processing, data systems, legal compliance, the executive director’s time, the audit itself. None of those belong to a single program and all of them have to be paid.

An organization funded entirely by restricted program grants has, on paper, a full budget, and in practice no money for the finance staff who administer the grants. The usual result is deferred maintenance on the organization itself: outdated systems, underpaid administrators, high turnover, and a board that cannot build reserves because every dollar arrived with a label.

This is the mechanism behind what sector researchers call the nonprofit starvation cycle. Funders press for low overhead ratios, organizations report low overhead to stay competitive, underinvestment follows, and capacity erodes in ways that eventually show up as program failure.

The overhead ratio problem

For years the standard advice was to pick charities by overhead percentage. That advice has been retired by most serious evaluators, for two reasons.

The first is that the ratio is manipulable. Allocation of shared costs between program and administration involves genuine judgment, and two honest organizations can report quite different ratios for identical operations. The second is that the ratio measures the wrong thing even when calculated carefully. A low ratio tells you an organization spends little on infrastructure. Whether that is discipline or neglect is not knowable from the number.

What to look at instead

Form 990 is public for most exempt organizations and it answers better questions than the overhead ratio does. The IRS explains the filing requirements and the public disclosure rules at irs.gov.

A few things on it are worth your time. Revenue concentration: how much comes from the single largest source, and what happens if that source leaves. Months of operating reserve: unrestricted net assets divided by monthly expenses, which tells you whether the organization can survive a late grant payment. The ratio of restricted to unrestricted support, which tells you how much room the board has. Compensation disclosure, which is itemized and which you can judge against organizational scale rather than against an abstraction. Consistency of program spending year over year, which distinguishes a stable operation from one lurching between grant cycles.

Also read the audit opinion if there is one, and read the notes. Restrictions are described there in detail that the summary figures hide.

How to decide what to give

Three questions settle it for most donors.

First, do you want to fund an activity or an organization? Funding an activity argues for restriction. Funding an organization argues against it, because an organization you trust will allocate better than you can from outside.

Second, is your gift large enough that a restriction creates real administrative work? Tracking and reporting on a restricted gift costs staff time. Below a certain size, the restriction can consume more capacity than the gift provides.

Third, is the restriction you have in mind one the organization can use? A gift restricted to a program the group is winding down becomes a liability rather than support.

Scale is worth keeping in view while you decide. KFF analysis of Census survey data, published in 2022 and reflecting 2021, found at least $220 billion in medical debt owed across the United States, and a KFF and NPR investigation that year found roughly 100 million adults carrying some form of health care debt. Those are 2021 and 2022 figures. Against a problem of that size, the choice between a restricted and an unrestricted gift matters less for the dollar amount than for how much discretion the receiving organization has in applying it. KFF publishes its analyses at kff.org, and the U.S. Census Bureau publishes the underlying income and poverty series at census.gov.

If you decide you want general operating support but still want evidence the organization is sound, the research work is the same work: read the 990, read the audit notes, check revenue concentration and reserves. Groups that compare organizations working on poverty publish their own methodology, and Fight For A Living Wage, a nonpartisan 501(c)(3) nonprofit, maintains a guide to comparing organizations that work on poverty that sets out the criteria it applies.

The practical summary

Restriction buys you specificity and costs the organization flexibility. Unrestricted giving buys flexibility and requires you to have done the diligence up front, because you are trusting judgment rather than directing it. Neither is the responsible choice in general. The responsible move is to know which one you are making and why, and to stop reading the overhead ratio as though it answered the question.