A 529 Plan is an education savings plan operated by a state or educational institution designed to help families set aside funds for future college costs. When college time comes, parents expect to be able to tap into their savings for the use it was intended, but beware! You could face penalties and taxes if you don't use it correctly.

1. Timing is Everything. Make the withdrawal the same year you are paying the bill. The IRS has not ruled on this yet, but if you withdraw the money in the prior calendar year, the transactions span two tax years, which could cause problems.
2. Expenses Must Qualify. These include tuition, fees, books, supplies and equipment, and room and board provided the student is enrolled at least half time.
3. Factor in Tax Credits. The American Opportunity Tax Credit alone is worth up to $2,500 per student. However, if you qualify for this credit, $4,000 would have to be subtracted from college expenses you could pay with your 529 dollars.
4. Fix Mistakes Quickly. If you realize you've taken out too much, you may roll the excess amount over within 60 days. Careful, though--you are only allowed one rollover for each 529 in a 12-month period.
5. Consider Routing Gifts into a 529. Assets contributed to a 529 no longer count as part of your state--hint to grandparents. Each grandparent can contribute up to $14,000 per year to a 529 without paying gift taxes, or they can contribute $70,000 in a single year and forego the next 5 years of gifts.

Source: TheWall Street Journal, Dodging 529-Plan Tax Traps