In Pennsylvania, you can get a state tax credit for contributions to 529 plans. So one financial planner helped his client, an elderly widow, endow her nieces and nephews with a way to pay for college, plus get her a $180,000 estate tax savings.

Funding children's educations is not only a wonderful way to help out family members, but it can also earn you a state tax deduction.

"If you are a grandparent or an older relative, and you have the assets to pay for education, there's a three-way benefit," says David Zalles, a tax planner in Blue Bell.

The grandparent or older relative pays for college and (hopefully) witnesses the gratitude; the parents are relieved from some financial responsibility; and the children in school receive the benefit of closer family ties and a reduced burden of college debt.

Zalles has a great example: One client, a widow in her 80s, didn't have children of her own. But she had substantial assets of about $3.4 million, not taxable federally because the amount is under the $5.25 million lifetime exemption.

However, upon her death, the state of Pennsylvania would levy a 15 percent estate tax on that $3.4 million amount. In Pennsylvania, inheritances by non-family members and non-lineal descendants are taxed at 15 percent.

However, Pennsylvania also has a special provision that shields assets within a state-sponsored 529 plan from the inheritance tax.

She told Zalles she wanted to fund 17 college educations - for 17 nieces and nephews - by funding each plan with the limit of $70,000 for each child. That totaled $1.19 million.

"This was her legacy to the family," he said. The students ranged in age from elementary school to college.

Zalles set up 17 different Vanguard Pennsylvania 529 plans to cover each student, and the widow funded them - with money that came from her estate. Immediately, she received $7,200 in tax credit on her Pennsylvania state return for that year. Ultimately she saved about $180,000 in Pennsylvania state tax payments.

Finding tax benefits

Visit the Tax Benefits for Education Information Center at the IRS website ( or check out Publication 970, Tax Benefits for Education, which can be downloaded at or ordered by calling 800-TAX-FORM (800-829-3676).