By cashing the bonds and rolling over the proceeds to a 529 plan, the FEDERAL tax on the interest is effectively postponed. The taxpayer fills out form 8815 and gets a Federal interest exclusion for the current year. His basis in the 529 plan is what he paid for the bonds. The 529 plan will record the savings bond interest as "earnings" on the 529 plan account.
When the beneficiary withdraws $ from the 529 plan for college, she takes an education exclusion on the earnings (the former savings bond interest)*. This is done on the fedearl return.
This works for private 529 plans as well as most state plans. I'm not familiar with all state 529 plans, but mine (Ohio) works for out of state colleges. You may be thinking of Pre paid tuition plans.
As an additional tax bonus, you probably get the state deduction. Even though it's sort of a rollover from USSB to a 529; it is, in actuality, a 529 plan contribution and eligible for the state deduction.
*For future reference: Since the taxpayer (pengland01 in this case) is the still the owner of the 529 plan, he/she will want the designate the eventual 529 plan withdrawals to go to school or the beneficiary (the niece) and not to him.
There's an additional benefit to rolling over savings bonds to a 529 plan. Room & board are "qualifying expenses" for a 529 plan withdrawal but not for cashing savings bonds and using the proceeds to directly pay for college.
