529 Plans Offer Tax Benefits
The best thing to happen to college savings in the last several years is the Section 529 plan, a tuition-savings plan for a child or grandchild. Once in the plan, assets build up tax-free until they're withdrawn.
Under the 2001 Tax Relief Act, withdrawals from state 529 plans will be tax-free if the money is used to pay tuition and other college costs.
How the Plans work
Specifics of plans vary by state. Unlike assets in a Uniform Transfer to Minors Act account, you keep control of the money in a 529 plan. You can take it back if you feel the person will misuse it.
Anyone can open a state 529 plan for a child--you do not have to be related.
There is no up-front federal tax deduction for money put in a 529 plan, although some states allow you to deduct contributions on your state tax return. Money builds up tax-sheltered until withdrawn to pay tuition bills or other educational expenses. Withdrawals from state 529 plans are completely tax-free.
Gift tax benefit
The normal limit on tax-free gifts is $10,000 per gift per year. Section 529 allows you to bunch five years of tax-free gifts into one year. Each donor can give $50,000 tax-free to fund a 529 plan—$100,000 in total from a married couple—every five years.