Parents who save money in 529 plans, tax-advantaged education investment accounts, for their children's graduate school years may end up disappointed.
Students change their minds, says Leonard Wright, a Nevada-based certified public accountant and personal financial specialist. Children could say they want to go to graduate school one moment, and then decide not to as late as their senior year in college.
In the time it takes students to decide, other financial consequences loom. Interest accrues on student loans from undergraduate education. A new employer may pay for graduate education. And the deadline for using college savings plan funds without paying a tax penalty gets closer.
Parents can weigh how much they should save for a student's graduate school expenses by answering the following questions.
[Learn how to stretch 529 plan savings for college and grad school.]
1. Does the student's career path require graduate school? Certain professions, such as accounting, require graduate school, Wright says. If a student wants to be a doctor or a lawyer, postgraduate school is also necessary.
"My inclination is not to go beyond paying for the first four years," says Nadine Lee, a New York-based certified public accountant and personal financial specialist.
If there isn't absolute certainty that the student will continue higher education past their first four years, use the money for undergraduate schooling first and then save money for graduate school outside of a 529 plan, she says. That way, a family can avoid tax penalties if graduate school savings are used for something other than education later, she says.
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2. Could the student find a job or internship that could cover graduate school costs? It's not unusual for businesses to pay for an employee's master's degree, especially an advanced business degree.
Wright says someone studying to be an accountant could get an internship in their later undergraduate years or after graduation where they may be paid $10 an hour, but the company will pay for graduate school.
The extra experience may help solidify a student's career goals or help the student decide he or she wants to study something else. Wright says what he studied in school as an accountant didn't provide a full picture of what his career would be like. His career path included much more financial planning than he expected.
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3. How much will graduate school cost? It doesn't make sense to save all 529 plan funds for a child's potential graduate school education if that degree will be cheaper than a bachelor's degree. Graduate degrees can be earned with as few as 36 credits, while undergraduate degrees are normally about 120 credits.
Even if graduate school credits cost 50 percent more at the same school, a graduate degree would still cost less than half the amount of an undergraduate degree. In other cases, graduate degrees are more expensive simply because of the school chosen.
Families need to look at undergraduate and graduate education as a package deal, says David Bendix, a certified public accountant from New York. Students may decide to go to a cheaper undergraduate program at a state university because they'd like to go to the Wharton School of Business at the University of Pennsylvania for an MBA, he says.
He discusses the cost of an undergraduate education and graduate education with his own children in terms of what the student is getting for the money.
4. How much debt will be accrued earning an undergraduate degree? One of the arguments for saving 529 plan funds for graduate school is that investments will earn more the longer money is invested. However, this doesn't apply as much if a student is financing an undergraduate degree with unsubsidized federal loans, where interest is accrued while the student is in school.
"This doesn't make sense if you're paying more in interest than you're earning," Lee says.
Maintaining high earnings would require stock market-based investments, which is too risky a strategy to use within a few years of when the money will be needed. At that point, it's "no longer investing, it's gambling," she says.