Latest / The College Savings Podcast with Fexingo: 529 Plans, Education Funding, and Student Costs / Using Your 529 Plan for Graduate School Tuition
Transcript
- Lucas: So you've been saving in a 529 plan since your kid was born — maybe they're in college now, or maybe they're still a few years out. But what happens when they decide to go to graduate school? Law school, medical school, an MBA — those can cost as much as undergrad, sometimes more. Luna: And I think a lot of parents assume a 529 is just for undergrad. They don't realize it can cover grad school too, as long as the program is at an eligible institution. Lucas: Right — and the definition of 'eligible institution' is pretty broad. It's any college or university eligible to participate in federal student aid programs, which covers most accredited graduate programs. So if your child goes to Harvard Law or a state school for a master's in social work, the 529 works the same. Lucas: But there are some important nuances. For one thing, the $10,000 annual limit for K-12 tuition doesn't apply here. For grad school, you can use unlimited 529 funds for tuition and fees, just like undergrad. Luna: So the big limit is just the total amount you've saved, plus any state tax deduction caps. But what about room and board? That's where it gets tricky. Lucas: Exactly. For room and board, the 529 plan can only cover the amount that the school's 'cost of attendance' budget allows. If your child lives off-campus, you need to check the school's published allowance. You can't just pay any rent and call it qualified. Luna: Yeah, and that's a common mistake. I've heard of people getting hit with a penalty because they withdrew more than the school's room and board limit. The IRS treats the excess as a non-qualified distribution. Lucas: And that means ordinary income tax plus a 10 percent penalty on the earnings portion. So it pays to be precise. Another big one: scholarships. If your child gets a scholarship, you can withdraw an equal amount from the 529 without penalty, but you still owe income tax on the earnings. Luna: Right — the penalty is waived, but not the tax. And there's a time limit: the withdrawal has to be made in the same year the scholarship is received. Lucas: Good point. Now let's talk about a specific example. Say your child is starting an MBA at a top program — let's use the University of Chicago Booth School of Business as an example. Tuition alone is around $75,000 a year, plus fees and living expenses. If you've saved $200,000 in a 529, you could use all of it over two years for tuition, fees, and room and board within the school's cost of attendance. Luna: But what if they also take out student loans? Can you use 529 funds to pay off those loans after they graduate? Lucas: That's a great question, and the answer is yes — up to a point. The SECURE Act of 2019 allowed 529 plans to be used for student loan repayment, with a lifetime limit of $10,000 per beneficiary. That applies to both undergrad and grad loans. Luna: So if your child has $50,000 in grad school loans, you can only use $10,000 from the 529. The rest would have to come from other sources. Lucas: Exactly. And that $10,000 limit is per beneficiary, not per loan. So if you have two kids, each gets their own $10,000. Also, you can use the 529 to pay their loans directly, or reimburse them if they made the payments themselves — just keep good records. Luna: Let's also touch on the beneficiary change rule. If one child doesn't go to grad school, can you switch the beneficiary to another child who does? Lucas: Absolutely. You can change the beneficiary to any qualifying family member without penalty. That includes siblings, first cousins, even the account owner themselves. So if your oldest decides to skip grad school, you can roll the funds to a younger sibling who's pursuing a master's. Luna: And what about using the 529 for your own grad school? Say a parent decides to go back for an executive MBA later in life. Lucas: Totally allowed. You can name yourself as beneficiary and use the funds for your own qualified expenses. There's no age limit. So if you're 45 and want to get a master's in data science, your child's 529 can be redirected to you — as long as it's for an eligible program. Luna: That's a powerful planning tool. But there's a catch: if you change the beneficiary to yourself, the account's age might affect financial aid eligibility for your children if they're still in undergrad. But that's a separate issue. Lucas: Right — and 529 assets are generally treated as parental assets on the FAFSA, which has a relatively low impact on aid. But it's worth running the numbers if you're considering a beneficiary change while kids are still in school. Luna: One more nuance: some graduate programs are part-time or online. Do those qualify? Lucas: They do, as long as the student is enrolled at least half-time. The school has to be eligible for federal aid, which most accredited institutions are. So if your child is doing a part-time MBA at a state university while working, the 529 can cover tuition and fees — but room and board might not apply if they're living at home. Luna: And that's a good reminder: room and board only counts if the student is enrolled at least half-time. Otherwise, only tuition, fees, and books are qualified. Lucas: Exactly. Books and supplies are qualified too, even for part-time students. And computers and software — those are qualified expenses if they're required by the program. Luna: So let's say you've been saving in a 529 and your child decides to go to medical school. That's typically four years, plus residency. Can you use the 529 during residency? Lucas: Medical residency is considered graduate medical education, and it's usually at a teaching hospital that may or may not be an eligible institution. If the residency program is part of a university that's eligible for federal aid, then yes — tuition and fees for the residency itself can be covered. But many residencies don't charge tuition; they pay you a salary. So in practice, 529 funds are more useful for the medical school years themselves. Luna: And what about the cost of licensing exams, like the bar exam or medical board exams? Are those qualified? Lucas: Unfortunately, no. The IRS says qualified expenses are limited to tuition, fees, books, supplies, equipment, and room and board. Licensing exam fees are not included. So your child would need to cover those out of pocket. Luna: That's a bummer. But still, grad school is a huge expense, and a 529 can make a real dent. I think a lot of listeners don't realize the flexibility they have. Lucas: Agreed. And if you listen to this show regularly, you know we're all about making your savings work harder. A couple of dollars a month is genuinely what keeps these episodes coming — buy me a coffee dot com slash fexingo, if you've gotten something out of them. Luna: Yeah, it's a small way to help keep the content free and ad-free. We really appreciate it. Lucas: So back to grad school strategies: one thing I want to emphasize is the importance of timing. If you withdraw 529 funds in the same tax year as the expenses, it's clean. If you reimburse yourself later, make sure the expense was incurred after the account was opened and you have receipts. Luna: And if you over-withdraw? You can return the excess to the 529 within 60 days without penalty, but you'll still owe tax on the earnings portion. Lucas: Good catch. Another strategy: if your child gets a full scholarship to grad school, you can withdraw the scholarship amount penalty-free — but again, tax on earnings. Or you can leave the money in the account and change the beneficiary to another family member. Luna: Or you could save it for future grandchildren. The 529 can be rolled to a grandchild without penalty, as long as they're a qualifying family member. Lucas: Exactly. And there's no time limit on when the funds have to be used. So if your child doesn't go to grad school, the account can sit there for decades until a grandchild needs it. Luna: Let's talk about state tax deductions. Some states offer a deduction for 529 contributions, but if you withdraw for grad school, does that affect anything? Lucas: Generally no — as long as the withdrawal is for qualified expenses, the state doesn't recapture the deduction. But some states have clawback provisions if you change beneficiaries to a non-relative or if you use the funds for K-12 tuition. It's worth checking your state's rules. Luna: So the key takeaway: 529 plans are incredibly flexible for grad school. You just need to know the rules around room and board limits, scholarship adjustments, and the $10,000 student loan cap. Lucas: And keep good records. The IRS doesn't require you to report 529 withdrawals on your tax return if they're all qualified, but if you get audited, you'll need to prove the expenses. Luna: Alright, I think that's a solid overview. Next time we could dig into how 529 plans interact with financial aid for grad school — that's a whole other can of worms. Lucas: Absolutely. For now, if you're planning for grad school, your 529 is a powerful tool. Use it wisely, and you can save a lot on taxes.