Why Scholarships Won’t Hurt Your Overall Financial Aid Picture

A graduate education is a big investment. Although graduate school can provide major financial rewards down the road, paying for that education in the present may seem overwhelming and even impossible. Fortunately, many universities, organizations and private individuals offer scholarship money to help graduate students go to school.

Sometimes, the way students think about graduate school scholarships discourages them from applying for great financial award opportunities at good schools. For example, they worry that scholarships will diminish their financial aid packages, or they worry about having to pay taxes on scholarship money. Knowing the truth about how scholarships work can help graduate school applicants make smart choices.

Scholarships and Financial Aid

Many students are afraid to compete for scholarship because they fear that the scholarship will decrease their need-based financial aid packages. For example, if a college has a tuition of $10,000 per year and a student can get need-based financial aid for $8,000, many students may believe that applying for a scholarship could reduce the amount of need-based aid the college is willing to offer.

It's true that a need calculation based on the Free Application for Federal Student Aid (FAFSA) usually determines the boundaries of a university's financial aid package. For example, someone who wins a $2,000 scholarship to the college mentioned before may only get $6,000 in need-based financial aid. However, students never have to pay back the scholarship money that they earn, although student loans must be paid back along with interest. According to the Department of Education, Perkins loans have an interest rate of 5 percent, and Stafford loans have an interest rate of 5.41 percent for graduate students. A student who takes out a $2,000 Stafford loan must pay back that loan plus an additional $108.20 for every year the loan is unpaid.

Scholarships and Taxation

According to IRS Publication 970, scholarship awards are not taxable as long as they meet the following conditions:

1. Qualified institution. The scholarship has to be awarded for classes taken at an educational institution. The institution must maintain a faculty, a curriculum and a regularly enrolled body of students at the place where it conducts its educational activities.
2. Qualified expenses. The scholarship money must be used to pay for tuition and fees at the qualified educational institution. It can also cover fees, books, required equipment or supplies. Learn more about qualified higher education expenses here.
3. Qualified courses. The student must be working toward a degree at the school. Scholarship money spent on continuing education or auditing of courses counts as taxable income.

Scholarships used to pay for room and board, optional equipment and travel are counted as taxable income. Money given for services rendered, such as teaching or research, is taxable if it is spent on living expenses. If the money is spent on qualified expenses, then the student doesn't have to report it on a 1040.

Reputable Sources for Scholarships

Avoid paying a service that promises to “find money for college.” Instead, try the U.S. Department of Labor's free scholarship search. Also, check with state grant agencies, employers and local civic organizations.Receiving a scholarship award from a university endowment, from an organization or from an individual looks prestigious as part of a resume or curriculum vitae. However, make sure to avoid the following pitfalls when applying for scholarships:

• Protect personal information. Students should never share identifying information with anyone unless they've initiated the contact. They should avoid sharing FAFSA PINs, and they should avoid filling out a FAFSA with anyone who isn't from the college's financial aid office or the Federal Student Aid Information Center. Companies that charge for FAFSA assistance may not handle personal information appropriately.
• Secure all documents. Keep all information about financial awards in a secure place. Shred documents once they're no longer needed.

Communicating With Financial Aid Offices

Students should ask their financial aid offices whether scholarship awards reduce gift aid or self-help aid first. For example, a university may not apply a scholarship against a gift grant, but it might choose not to offer a teaching assistantship to a scholarship student. Also, students should report all outside scholarships to the university's Financial Aid office to avoid having to pay the university back for overawards.

Students concerned about paying for their studies undoubtedly benefit from scholarship money, but understanding how scholarship money works is crucial to making the right financial decisions for your educational future.