Consumer Reports: Withdrawing from a 529 college savings plan

Parents who've been saving for years, know the advantages of putting college money into a 529 college-savings account. You get big tax breaks on the money.

But what happens when it's finally time to take the money out? Financial experts at Consumer Reports say there are smart ways to do that, too.

When Kim Johnson's daughter, Isabelle was born, Kim began putting money into a 529 college savings plan, and although it's hard for Kim to believe, Isabelle is now a college freshman, and it's time to start taking money out of her 529. Which is a little more complicated than Kim expected.

"We just thought, you know, it's there, it's a bucket of money that we've been saving and most recently we are starting to learn that there are some strings attached and rules," Johnson said.

Rules that are important to follow, according to the financial team at Consumer Reports, if you want to avoid hefty penalties.

"If you don't spend the money on legitimate 529 expense, you'll pay income tax on the earnings in the 529 and a 10 percent penalty on the amount you saved," said Donna Rosato of Consumer Reports.

Legitimate 529 expenses include obvious things, such as tuition and supplies, like books and computer, but you can also use the money towards room and board, if you're enrolled in school at least half-time.

As you spend, be sure to keep all your receipt, the IRS may have questions later.

Be aware that when you spend the money also matters.

"You need to spend the money in the same year that you make the withdrawal. That means the calendar year, not the school year," Rosato said.

And, if you're lucky enough to have leftover 529 funds? Avoid taxes and penalties by saving it for graduate school or transferring the money to another child, a cousin or even to further your own education.

Consumer Reports says sometimes you can even use 529 money towards education costs for students in kindergarten through 12th grade, but only up to $10,000 per-student, per year. Just be sure to check with your plan administrator, to find out what's covered in the plan you have chosen.

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