Saving for college: Picking the right plan might save your ass-ets

In my last article, I discussed the vehicles physician families might use to save for college, and the 529 college savings plan is the best choice for most physician families. So, which 529 is right for you?

This part of saving for college can be confusing, and rightfully so.

Let me be the first to say that the product launch of the 529 plan will go down in financial history as one of the worst blunders ever. Why do I feel this way?

  • There are actually TWO kinds of plans created under IRS Section 529: prepaid tuition plans, and true college savings plans. Here, we're only concerned with the true blue college savings plan.
  • The plans were originally created under state law in separate states, so no two plans are exactly alike, increasing the confusion about which to use.
  • Some plans are sold directly - without commissions - and some are sold indirectly through stockbrokers and insurance people WITH commissions, bringing even greater confusion about "which is best".

At this moment, there are at least 80 plans available in 48 states, begging the question about which state's plan to use. Most physicians I meet have NOT funded a 529 plan because they don't know which state is right for them, and many physicians think the only plan they can use is the plan offered by the state in which they live.

So let me clear the air here with this statement:

No matter which state's plan you put your money into, as long as it's a true college savings plan (not a pre-paid tuition plan), your student can use the money to attend any institution that qualifies under the rules in any state (or galaxy, for that matter).

That means you can live in Oregon, put your money in the Utah plan, and send your kid to Dartmouth.

So you're probably wondering which plan is best for your family, a family with at least one physician actively engaged in the practice of medicine. If you were just the average American family, you might find the answer in Consumer Reports or Morningstar (a fund rating firm), in which case they usually recommend Utah's plan and Nebraska's plans due to their very low cost and flexible investment offerings.

But you're not average. You're a doctor.

So the place you begin looking for a plan is in your own back yard, for two reasons:

  1. Income taxes: Some state-sponsored plans make tax breaks available to their residents. Though these tax breaks are often small (less than $500 in most cases), they're worth having.
  2. Asset protection: While 529 plans receive protection under the Bankruptcy Abuse Prevention Act, they're only protected if you actually declare bankruptcy. Ugh! However, you may find yourself wrangling with a malpractice claim in a situation where you're NOT going to declare bankruptcy, in which case you may find yourself relying on your state's asset protection laws. From what we've seen and read, 529 plan asset protection created by state laws seems to only apply to the residents of the state who participate in that state's plan (check out this blog post from the Florida Asset Protection Blog for an example). This isn't legal advice, so consult your attorney for details.

Once you've decided to stay in your home state, find out which plans are "direct-sold" and which are "broker-sold". The direct-sold plans are not really "sold" at all. They're commission-free plans that are self-service, meaning you pick your investments yourself, and you open the account yourself.

So why would anybody pay a commission to get into a 529 plan? The only reason I can really think of would be service. (The broker-sold 529 plans usually have lower investment returns due to higher costs). And you only need this service if you either don't know how to do it yourself, or you don't want to bother with it.

If you don't know how to do it yourself but you would like to learn, stay tuned.