Objective: Cognitive reserve is a concept that explains individual differences in resilience to brain pathology and susceptibility to poor late-life cognitive outcomes. We evaluate the analogous concept of “Functional Reserve,” defined as the difference between observed functional abilities and those predicted by brain structure, cognitive performance, and demographics. This study aims to validate the construct of functional reserve by testing its utility in predicting clinical outcomes and exploring its predictors. Method: Longitudinal data collected annually for up to 7 years from 1,084 older adults (ndementia = 163; nMCI = 333; nCN = 523) were analyzed. Functional reserve was operationalized as the residual variance in the Lawton-Brody Instrumental Activities of Daily Living (IADL) Scale after accounting for demographics (sex/gender, race, ethnicity, education), neuropathology (gray matter, hippocampal, and white matter hyperintensity volumes), and cognition (executive function, verbal episodic memory, semantic memory, and spatial function). Structural equation models estimated (a) functional reserve’s associations with 7-year changes in clinical diagnosis and disease severity and (b) predictors of functional reserve. Results: Functional reserve was lower in dementia versus cognitively normal individuals. Higher baseline functional reserve was associated with lower concurrent dementia severity and slower clinical progression and attenuated the association of cognition with concurrent dementia severity. Physical function and apathy were the strongest predictors of functional reserve. Conclusions: Results provide preliminary validation of functional reserve for explaining individual differences in susceptibility to IADL dysfunction independent of neuropathology, cognition, and demographics. Physical functioning and apathy are promising modifiable intervention targets to enhance functional reserve in the context of brain atrophy and cognitive decline.