What Is Restricted vs Unrestricted Income in Charities

Charities rely on a mixture of grants, donations, fundraising and trading income. Not all money can be used in the same way. Some funds must be spent on specific projects while others can be used wherever the charity needs them most. For trustees, financial officers and volunteers, understanding the difference between restricted and unrestricted income is vital. It affects budgeting, reporting, governance and the long term stability of the charity.

The Charities Act 2011 requires charities to manage and apply funds according to the purposes for which they were given. Misusing funds can damage trust, create legal issues and lead to regulatory scrutiny. This article explains the difference clearly, using plain language, real examples and practical guidance so that any charity can manage its money with confidence.

Why the Distinction Matters

Charities often run multiple activities at once. A youth group may run mentoring, sports programmes and food support. A church may run community outreach, counselling services and building maintenance. A single charity can therefore receive money for many different reasons. Some income is given with instructions while some arrives without conditions.

The distinction matters because:

• donors expect their money to be used as intended

• funders may impose legal terms

• trustees must be able to demonstrate compliance

• annual accounts must present restricted and unrestricted funds separately

• misuse can trigger Charity Commission intervention

Good practice requires trustees to understand what type of income they are receiving and how it must be allocated.

What Is Restricted Income

Restricted income (also called restricted funds) refers to money given to a charity for a specific purpose. The donor or funder sets the restriction and the charity is legally obliged to honour it. Restricted income cannot be used for anything outside the agreed purpose.

Restrictions can apply to:

• grants

• donations

• legacies

• fundraising appeals

• major gifts

• event income designated for a clear project

Restricted income must be tracked separately from unrestricted income. It often appears in the accounts as a distinct fund.

Key features of restricted income

• It must be spent only on the specific purpose agreed

• It cannot be moved to general funds

• It may have conditions or reporting requirements

• It must be ring fenced in the accounts

• It can only be removed once fully spent or permission is obtained to change the restriction

Restrictions apply whether they are written formally in a grant agreement or stated verbally by the donor if the donor’s intention is clear and recorded.

Types of Restricted Funds

Restricted funds fall into two main categories.

1. Restricted income funds

These funds must be spent on a specific activity. Examples include:

• a grant to deliver a youth mentoring programme

• donations for a new roof at a church

• fundraising income for a community food bank

• a sponsorship to run wellbeing workshops

The restriction applies to spending not timing. The charity can use the funds only for the designated activity but may be free to choose when the activity occurs unless specified.

2. Restricted capital funds

These funds must be used to buy or improve an asset. For example:

• a grant to purchase a minibus

• a donation to build a playground

• funds given to renovate a community centre

Some capital funds require that the asset itself must be used for a charitable purpose for a minimum number of years.

Libraries, churches, community centres and schools often receive restricted capital funds.

What Counts as a Restriction

Restrictions arise when a donor or funder clearly expresses how the money must be used. This can occur through:

• grant agreements

• funding contracts

• written instructions from donors

• online appeal wording

• verbal instructions documented by the charity

• fundraising campaigns for a specific project

If a charity launches an appeal for something specific the funds become restricted even if donors do not individually impose conditions.

For example:

If a charity runs an appeal called “Help Us Buy a Minibus” every donation to that campaign is restricted to the purchase of a minibus.

Trustees cannot divert those funds to general running costs unless donors provide consent.

What Is Unrestricted Income

Unrestricted income (also called unrestricted funds or general funds) can be spent on any charitable activity that aligns with the charity’s objects. There are no donor imposed restrictions.

Examples include:

• general donations

• Gift Aid

• membership fees

• income from trading

• hall hire fees

• fundraising events without specified purposes

• legacies not tied to a project

• interest and investment income

Unrestricted funds give trustees flexibility. They can use the money to pay:

• rent

• utilities

• staff

• governance costs

• insurance

• general operations

• future planning

• urgent needs

This freedom is vital because many of the charity’s core costs cannot be covered by restricted grants.

When Unrestricted Funds Become “Designated”

Trustees can choose to set money aside for a specific purpose voluntarily. This is called a designated fund. It is not the same as restricted income.

Key points:

• designated funds are optional

• trustees can reverse or amend the designation

• the designation is internal and not legally binding

• they still form part of unrestricted reserves

Common reasons for designation include:

• saving for building repairs

• future projects

• contingency planning

• equipment replacement

• digital transformation

Designated funds improve planning but do not create legal restrictions.

How to Identify Whether Income Is Restricted or Unrestricted

Trustees should ask four questions:

1. Did the donor specify how the money must be used?

If yes, it is restricted.

2. Did the charity create a specific appeal or campaign?

If yes, it is restricted to that purpose.

3. Is the money from a grant?

Grants are usually restricted unless the funder states it can be used for general costs.

4. Is the charity voluntarily setting the money aside?

If yes, it is designated not restricted.

Understanding these questions ensures income is recorded correctly from day one.

Examples of Restricted vs Unrestricted Income

Example 1: General donation

A donor gives £100 without specifying a purpose.
This is unrestricted.

Example 2: Donation for the building fund

A donor gives £500 and says it must go towards building repairs.
This is restricted.

Example 3: Grant for youth workshops

A local authority awards £10,000 to run youth workshops with a full reporting schedule.
This is restricted.

Example 4: Fundraising for new musical equipment

A choir raises £2,000 through a concert specifically advertised for purchasing new equipment.
This is restricted.

Example 5: Income from hiring a hall

A charity hires out its building for events and earns £3,000.
This is unrestricted.

Example 6: Trustees setting aside £1,500 for future IT upgrades

This is designated unrestricted.

Why Restricted Funds Feel Challenging for Trustees

Restricted funds protect donor intent but they can create pressure on trustees, especially small volunteer led charities.

Common challenges include:

• funds cannot be used for core costs

• delays if the charity cannot deliver the project quickly

• admin burden from reporting requirements

• difficulty matching restricted income with actual project timing

• holding unspent restricted funds for long periods

Many charities have healthy restricted balances but fragile unrestricted reserves. This is known informally as being “rich on paper but poor in practice.”

Good budgeting balances both types of income.

Charity Commission Requirements

The Charity Commission expects charities to:

• record restricted and unrestricted funds separately

• keep evidence of donor instructions

• apply funds only to their intended purpose

• produce accounts that clearly distinguish between fund types

• avoid using restricted funds for general costs

• document decisions on designated funds

Failure to manage funds correctly may lead to:

• breach of trust

• regulatory action

• repayment of grants

• reputational damage

• trustee liability in serious cases

Good financial controls protect both the charity and its trustees.

How Restricted Funds Must Be Reported in Accounts

Annual accounts must show restricted and unrestricted income separately. The Charities SORP sets out clear rules.

A typical statement of financial activities (SOFA) must include:

• unrestricted income

• restricted income

• unrestricted expenditure

• restricted expenditure

• transfers between funds

• closing fund balances

Explanatory notes must detail:

• the purpose of each restricted fund

• opening and closing balances

• how the fund was used

• any unspent amounts carried forward

Clear reporting reassures donors and regulators.

What Happens if Restricted Funds Cannot Be Used

Sometimes charities receive restricted funds they can no longer use. This may happen if:

• the project ends

• the need no longer exists

• the charity closes

• fewer beneficiaries come forward

• the cost is different from what was planned

Trustees cannot simply move the money to general funds.

Instead they must:

1. Review the governing document

2. Contact the donor or funder to request written permission to change the restriction

3. If donors cannot be contacted apply to the Charity Commission for consent

4. Document every step

The Commission can approve the release or amendment of a restriction if it is impossible, impractical or outdated.

Real World Examples

Example 1: Church roof repairs

A church raises £15,000 for roof repairs. The repairs cost only £12,000. The remaining £3,000 is still restricted to building works. The church must contact donors or reassign funds through the Charity Commission process.

Example 2: Community group receiving a grant

A community group is awarded £20,000 to deliver mental health support sessions. The sessions must be delivered as stated. Unused funds must be returned or repurposed with written permission.

Example 3: Charity running a food bank

General donations go to unrestricted funds so they can be used for electricity, admin and volunteer management. Donations given specifically “for food” become restricted.

Example 4: Legacy gift without conditions

A donor leaves £50,000 in a will with no instructions. The charity can use it as general unrestricted income.

How to Manage Restricted and Unrestricted Funds Effectively

1. Keep separate accounting records

Use fund codes or tracking categories.

2. Record donor instructions immediately

Store email, letters or grant agreements.

3. Review funds at each trustee meeting

Check spending progress.

4. Prepare realistic budgets

Avoid accepting restricted funds you cannot use.

5. Strengthen unrestricted fundraising

Unrestricted reserves keep the charity running when restricted funds cannot.

6. Explain the difference to donors

Many donors give restricted money by accident. Clear communication helps.

When Charities Should Seek Professional Advice

Advice from an accountant or charity specialist is beneficial when:

• restricted funds remain unspent

• you want to redesignate funds

• reporting requirements feel unclear

• grant conditions are complex

• a legacy has unclear restrictions

• the charity is restructuring or merging

• restricted and unrestricted funds have been mixed

Good advice prevents errors that can cause regulatory issues later.

Conclusion

Restricted and unrestricted income are central concepts in charity finance. Restricted income must be spent only on the specific purpose intended by the donor while unrestricted income can be used for any activity that supports the charity’s general objectives. Trustees must understand the distinction because it affects budgeting, reporting, governance and legal compliance.

Managing funds properly protects donor trust and ensures the charity uses resources where they are most needed. By keeping clear records, separating fund types and following Charity Commission guidance, charities can operate confidently and transparently while fulfilling their mission effectively.