What you heard is not correct (or you misunderstood). If a number of conditions are met, you can avoid tax on savings bond interest equal to the amount of tuition that you paid yourself, not tuition or other expenses that were paid by scholarships. You have to pay the tuition, or contribute to a 529 plan, in the same year that you cash in the savings bonds. There is no way to avoid tax and use the money as disposable income. Only Series EE and Series I bonds are eligible, and as I said, there are a number of other conditions that must be met. You can read all the details in Chapter 10, Education Savings Bond Program, in IRS Publication 970.
