The National Scholarship Providers Association recently released its highly anticipated white paper on award displacement—a complex issue for students seeking scholarships and the higher education institutions charged with creating financial aid award packages. By way of background, award displacement is best understood as a practice by colleges and universities to replace one form of financial aid (typically loans and grants) with another source (typically private scholarships) rather than treat scholarships as supplemental aid. For purposes of simplicity in this blog, we follow the NSPA article language and include all four year colleges and universities in the generic term “institution.”

While on the surface award displacement may sound like a reasonable practice, its practical application has a severe impact on making higher education affordable to low- and median-income students. Clearly the goal of any need-based financial aid program is to ensure that students who would otherwise be unable to afford the cost of higher education have the means (or partial means) to attend such institution. Award displacement affects the amount of aid ultimately granted to certain students, and adversely affects the student’s (and their family’s) financial bottom line.

The white paper offers the following key findings:

• When a private scholarship results in a student receiving more money for his/her college bills than the federal financial aid formula says the student  needs (an “overaward”), four fifths of the institutions surveyed reduce the loans and work requirements in a student’s financial aid package (self-help aid), and half reduced their own institutional grants or scholarships (gift aid).
• Half of institutions contacted the scholarship donor and/or the student to discuss options for dealing with the overaward situation. Almost one third increase the student’s overall cost of college, the COA, for education-related expenses and indirect costs.
• One sixth of the institutions reduced state gift aid, mainly because many states require institutions to treat state grants as last dollar, which requires the state grant to be reduced ahead of all other forms of financial aid in a student’s financial aid package.

Examples of Displacement

According to the NSPA’s research, gleaned from a 2011 survey of 61 responses from 100 institutions, award displacement comes in several varieties, illustrated by the following examples:

Displacement by Overaward.  The student’s demonstrated financial need is $30,000, and the student receives a financial aid package in the amount of $20,000 (in loans and grants) plus a private scholarship in the amount of $15,000. The student’s overaward amount is $5,000, and depending on the nature of the “first dollar” and “last dollar” amounts, the school will likely reduce the financial aid award by $5,000. Whether this is in the form of reduced federal loans or reduced grant amounts is governed by federal regulations and the school’s financial aid policies.

Effect of Student Contributions/Self-Help and “Gapping.” Not all institutions offer financial aid packages that meet all of a student’s financial need. Institutions may reduce financial aid when a student receives a scholarship, rather than allow the scholarship to fill the gap. Generally the expected family contribution (“EFC”) is an amount determined by federal formulas that is a reasonable amount for the student/family to contribute to the cost of higher education. A student who is expected to contribute $5,000 earns a scholarship in the amount of $2,500. Rather than reduce the expected contribution, the institution instead reduces the amount of other aid by $2,500 and leaves the expected contribution amount intact.  In the most extreme circumstances, some of these students may be earning this money as a bread winner for their family, and when the university requires them to submit a summer earning contribution to defray their education costs, their family is left in a financial deficit.

Lost Opportunity in Restrictive Scholarships. Limiting a scholarship purpose, by the donor, to too narrow a purpose can displace a similarly restrictive scholarship awarded for the same purpose. If a student receives both a scholarship and other forms of financial aid, both earmarked for tuition, and the combined amount exceeds the tuition expenses, one may be wholly or partially disallowed and the student is left without means to pay living expenses.

Fewer Renewal Scholarships. Using a sliding scale of awards, many institutions offer more grants than loans in early (freshman and sophomore) years and reverse the trend in the final years based on the anticipation that the student will continue to receive a renewal scholarship. This is considered a hidden displacement and may be the basis for scholarship providers to opt out of multi-year or renewal scholarships.

Regardless of the type of award displacement employed, the result is the same: a reduction of the amount of other forms of financial aid available to qualified students when such students are also awarded private scholarships.  While the above discussion pertains to undergraduate institutions, the effect of award displacement contributes to the long term problem of students in debt upon graduation. And, per the NSPA research, students with debt at graduation are 50% less likely to pursue graduate degree programs, impacting their ability to pursue fields requiring advanced academic degrees.

Process Specifics and Other Related Issues

Institution financial aid policies and discretionary professional judgment, coupled with federal regulations, determine award displacement and dictate how and when aid is displaced. Certain kinds of federal aid (e.g., the Pell Grant) are considered “first dollar” aid and not subject to reduction, while other forms are considered “last dollar” (e.g., Perkins loans, Federal Work Study programs, Stafford Loans) and are eligible to be eliminated if supplanted by private scholarship funds. If the private scholarship is awarded after the institution offers a need-based financial aid package, the student may be required to repay overaward funds. Most institutions do allow an overaward tolerance amount of $300, which is determined by the type of federal aid awarded. The tolerance cushion is a balance between the extra money a student may keep and use for personal expenses versus the work involved on the part of the institution to re-write the financial aid package to reduce overall award by $300.

The impact of a non-award displacement policy/practice by the university has an effect on its financial health as well, and some institutions argue that without award displacement for some students, they would be unable to keep a balanced financial opportunity for need based students as a whole, and in some cases that they will be ineligible to meet the 90/10 formula applicable to the percentage of institution revenues from Title IV federal student aid.

Because we are tax specialists, we would be remiss if we didn’t touch on the tax liability associated with scholarships. Such amounts used by students for tuition, required fees, books, supplies and equipment are excluded from income, but amounts awarded and applied to living expenses are taxable. Coupled with restrictions of the American Opportunity Tax Credit, students who receive tax-free scholarship money have reduced eligibility for the AOTC.  Conversely, non-tuition-restricted scholarship funds can become a source of tax revenue for the IRS, to the recipient student’s disadvantage. The NSPA white paper includes recommendations for scholarship providers (who may think they are helping by being restrictive)  to be more flexible in the designated purpose of the scholarship funds to allow students a broader use of the money.

More Information

We’ll cover more on this topic and break down recommendations for changes to federal financial aid policies, institution practices, and scholarship provider policies in an upcoming post.  For more detailed analysis, a wealth of data on financial aid and student retention, and recommendations by the NSPA for improvement, check out the white paper in its entirety on the NSPA website.

At Leaffer Law, we will continue to monitor developments resulting from the NSPA white paper and related scholarship issues, and will advise readers of these developments in future blog postings.