By James Mwombela, CFP®
So you were accepted to a top-notch MBA program, and you will be starting in the fall. Congrats! You must feel proud of your achievements. You may be looking forward to applying your real world experience to the classroom and equipping yourself with more tools to hone your craft. Putting together the most advantageous strategy to pay for your MBA is probably one of the last things you want to do. Since we have a lot of experience with this situation, we put together a quick guide to help you out.
Assessing your situation
The first step is to tally up all the costs you will face while pursuing your MBA. Assuming you will be enrolled full-time in a top-20 program, tuition will cost between $60,000 and $74,000 per year. Fees and books raise your costs to somewhere between $66,000 and $80,000. Don’t forget personal expenses, because those don’t go away. Also remember that the purpose of an MBA is to build your knowledge and your professional network. It would be wise to factor in the cost of light travel, food, and beverages for social events. Let’s say you will spend $18,000 a year for rent and utilities ($1,500 per month) and $24,000 for regular living expenses and social events (~$2,000 per month). If we assume a middle-of-the-road $73,000 figure for tuition, fees, and books, that brings your total to $115,000 per year. Before moving on, it is important to ask yourself, what lifestyle expenses can you cut temporarily to make room for this important endeavor? Perhaps you could make your own coffee and lunch, get rid of cable, or dump the gym membership and other monthly subscriptions that you are not using.
The next step is to add up sources of financial assistance and income. This could include employer assistance, scholarships, fellowships, financial aid, your spouse/partner’s income, or help from your parents and relatives. Since many of our clients do not come from wealthy backgrounds, help from relatives may not be an option. You will likely have a summer internship your first year and earn between $20,000 and $30,000.
Should you use savings or take out loans?
The third step is to calculate the difference between the total cost figure tallied in Step 1 and the total income/financial assistance calculated in Step 2. That difference must come from your savings, loans, or a combination of the two. If you have savings, using that to fund the gap is probably ideal in order to avoid or minimize debt. Debt brings interest costs, limits your cash flow when you graduate, and increases your debt-to-income ratio. A higher debt-to-income ratio could hurt your ability to obtain favorable financing to purchase a home or car or even invest in a future business. If you decide to use your savings, don’t forget to keep enough on hand for emergencies. A rule of thumb is to save an amount equal to at least six to nine months of regular living expenses. A good question to ask yourself is - how much money do you need sitting in the bank to feel warm and fuzzy inside?
If you want to go the entrepreneurial route following graduation, taking out student loans now could actually be a good move. If you borrow now instead of later and use your savings for startup costs, you would be effectively “pre-financing” some of the startup costs at a lower interest rate. If you spend down your savings while getting your MBA, you would be left with the following two options for financing your business: (1) borrow at a higher interest rate or (2) angel or venture capital investments which would likely require you to part with equity in your business. According to the U.S. Small Business Administration, new businesses receive about three-quarters of their funding from loans, credit cards, and lines of credit. With an average of $10,000 to $80,000 in startup capital needs and 10-20% interest on the debt (compared to 6-10% for student loans), interest costs could become a significant burden. A useful rule of thumb is to take on no more than 1x your income in debt or ideally no more than half. For those not planning to start a business, the amount of debt you can afford to take on is based on your potential compensation. For instance, one of our clients is projected to earn between $150,000 and $200,000 in salary and bonus upon graduation. This gives him the option to finance a significant portion of his MBA costs.
Which bucket of money should you use?
Cash or investments outside of your employer retirement plan/401(k) should be the first place to go. Since 2020 will be an unusually low income year for you, you will likely qualify for 0% capital gains taxes. This allows you to liquidate stocks at a profit and avoid some or all capital gains taxes (usually 15%), and you may never get this opportunity again.
We typically discourage early withdrawals from qualified retirement plans such as 401(k)s. You would owe taxes plus a 10% early withdrawal penalty. In addition, you would forego the benefit of compounding returns on the principal balance, taxes, and penalty dollars withdrawn from the account. You could potentially take advantage of an exception to the 10% penalty for higher education expenses if you roll over some or all of your 401(k) funds to an IRA. You would still owe taxes on IRA distributions, but you will be in a low tax bracket in 2020 due to unusually low income. However, there are other investment and tax consequences of executing a rollover to an IRA that should be considered before doing so.
Employee stock plans or stock options could be a great source of money for MBA costs. Liquidating this stock could allow you to kill three birds with one stone: 1) paying for your MBA 2) reducing your concentration risk and 3) saving money on taxes. It is important to consider the rules of your specific employee stock plan before taking action, or you could end up paying unnecessary taxes. As a rule of thumb, you should avoid allocating more than 10% of your total portfolio to any one stock in order to avoid being too concentrated in that stock. If you are confident in the future of the company, it may be okay to bend this rule of thumb as long as you are aware of the risks.
Once you have accounted for all your resources and savings, any remaining gap must be covered by loans.
Planning to pay for your MBA requires many of the same positive habits that you have probably established to help you reach this point. It is important to have a realistic estimate of your costs, take advantage of all resources available to you, be mindful of lifestyle expenses, plan for the unexpected, and avoid excessive debt. For the finer details such as tax minimization strategies, navigating the rules of your employer investment accounts, and understanding how these decisions affect your other financial goals, it may be helpful to sit down with a financial planner who is experienced in helping people in your situation.