Tapping a 529 Plan: 5 Tips to Get the Most Out of College Savings

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Apart from retirement, saving for college expenses is one of the longest-term goals that families set for their finances. After scrimping for years to build up your college savings, the last thing you want to do is make mistakes that will cost you when it comes time to make withdrawals.

If you've used 529 plans to save for college, making the most of the available tax advantages is just part of the picture. Here are five tips for making the most of your 529 plan cash.

1. Spend Your 529 Plan Money on the Right Expenses

You're allowed to get tax-free treatment on withdrawals for qualified higher education expenses. Those expenses include tuition, fees, books, supplies and equipment.

If the student attends college at least half-time or more, room and board also qualifies -- but the amount is limited to a figure set by the school. So if the student lives off-campus, ask the school for its maximum.

2. Don't Waste Your Opportunities for Other Tax Credits

Even if you have enough 529 plan money to cover every penny of your college expenses, you still might not want to withdraw the full amount you owe. That's because multiple tax breaks are available for college expenses, but you can only use each dollar of expenses for one benefit.

%VIRTUAL-article-sponsoredlinks%Specifically, many students and parents are eligible for the American Opportunity credit, which gives a tax credit of 100 percent of the first $2,000 and 25 percent of the next $2,000 of educational expenses. You can use 529 plan money to claim that credit, but if you do, then it won't be eligible for the usual tax-free treatment on 529 plan distributions. Yet you definitely don't want to miss out on what could be as much as $2,500 in free tax credits, so being smart with your planning involves using expenses where they'll help you and your kids the most.

3. Know the Implications of Who Gets the Check

Most 529 plans give you a choice to have withdrawals paid to you, your student or the college. Having money go directly to the school might seem to make the most sense, but some experts worry that can affect a student's financial aid from the school.

Having money paid to a parent or the student can raise tax-audit flags. Parents and students should keep meticulous records matching up money withdrawn from 529 plans to the qualifying expenses to convince the Internal Revenue Service that they in fact used withdrawals for eligible expenses.

4. Get the Timing Right

Schools don't typically use the calendar-year system that the IRS uses. So while withdrawing a full school year's worth of expenses might seem like the simplest, it won't pass muster with the IRS.

Rather, the IRS wants to see you take money out in the same calendar year in which it's due. So if your spring-semester bill isn't due until January, wait until January to take that money out of your 529 plan account.

5. Be Smart About Scholarships

One frequent concern among 529 plan savers is that their child will get a scholarship and not need the 529 plan money. If that happens, you can withdraw the scholarship amount from the 529 plan account. It won't be treated as a tax-free distribution, but you won't owe a 10 percent penalty on that amount.

Whether you want to take a scholarship-exception withdrawal depends on how much money you have in the 529 plan, what future expenses might be, and whether you have other children who need college money. But if this is the last chance to get money out of a 529 plan without paying a penalty, it's usually worth it to avoid paying more later on.

You can follow Motley Fool contributor Dan Caplinger on Twitter @DanCaplinger or on Google+.