These plans have become more popular over the past few years. Let's look at a few pros and cons of 529 plans;
You may deposit up to 5X the annual gift limit (in 2006, the limit is $12,000, so you can give $60,000 per recipient and treat it as 5 years' of annual gifts. No gift tax is due, but you must file form 709 to declare the amount over $12,000)
Money can grow and be withdrawn tax-free (current tax law).
Funds can be designated for a different relative should the intended child not go to college.
The 'approved relative' list follows;
1.Child or descendant of a child.
2.Brother, sister, stepbrother, or stepsister.
3.Father or mother or ancestor of either.
4.Stepfather or stepmother.
5.Son or daughter of a brother or sister.
6.Brother or sister of father or mother.
7.Son-in-law, daughter-in-law, father-in-law, mother-in-law, brother-in-law, or sister-in-law.
8.The spouse of any individual listed above.
There is no required distribution, thus you can save early for a yet unborn grandchild if you wish (by designating a child and then changing the beneficiary once the grandchild is born.)
Should you need to withdraw the funds and not use for school, regular income tax rates (not cap gain) apply as well as a 10% penalty.
Fund choices are typically very limited, and you may only change funds once per year.
Tip - MBNA offers a credit card linked to a Fidelity 529 account. You get 1.5% cash back on all purchases up to a $1500/yr rebate. ($100,000 in spending) There is no annual fee on the card and no annual fee on the 529 account. This is a painless way to save and a far better return than 'miles' cards.
(11/06 update - this used to be a 2% rebate. Today it was cut back to 1.5%, As many other rebate cards have reduced their percentages)