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Key College Savings Plan Still Unknown to Many Americans

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As college tuition costs continue to rise, with the average graduate this year burdened with about $27,000 in student loan debt, students and families are increasingly looking for sensible ways to finance the cost of a college education.

Yet, while American families are looking for ways to make their college dollars go further, a new study by Edward Jones suggests that a disconcerting number of Americans are still unaware of savings options like 529 plans, investment vehicles designed to encourage saving for college expenses by offering their owners generous federal and state tax incentives.

More than two-thirds of Americans don't even know what a 529 savings plan is, according to the study. The lack of awareness confirms the results of another study released earlier this month by the Credit Union National Association, which found that high school students applying to college lacked basic financial literacy.

The cost of going to college "can be a daunting figure for families to navigate," said Greg Dosmann, a partner at Edward Jones who focuses on college savings. "Tackling this goal over the long term can reduce much of the stress caused by those costs."

"We tell our clients that it can take a family to fund a 529 plan," he added, "and by taking a long-term savings approach through a vehicle like a 529 plan, families can chip away at the final costs over a period of 15 or more years."

The 529 plans vary by the states or educational institutions offering them. Some offer investments in stock and bond mutual funds. Others offer FDIC-insured funds, much like a savings account. They funds are maintained by asset managers, to which families pay a fee. What's more, families can change their allocations in the funds once a year without a tax penalty.

(Read More: How Much Americans Think Families Need to Get By)

The study also found a stark disparity in levels of awareness of savings options along socioeconomic lines, with wealthier Americans more well-informed than their less well-off counterparts.

According to the study, just 18 percent of respondents with household incomes of less than $35,000 knew what a 529 plan was, compared to 32 percent of those with incomes of $35,000 to $50,000 and 51 percent of those with incomes of $100,000 and up.

"While we look to find long term solutions to combat the rising cost of college tuition, right now 529 college savings plans remain one of the most affordable ways for families to save for higher education and reduce their reliance on student loans," Michael L. Fitzgerald, chair of the College Savings Plans Network and state treasurer of Iowa, said in a statement. "We're seeing more and more American families making a commitment to invest long-term in higher education."

The plans' main advantages are the tax incentives. The growth and investment gains made on money in a 529 plan is tax-deferred, and withdrawals can be made at any time without penalties, so long as the funds are used for college-related expenses.

(Read More: How Mapping Student Debt Changes the Debate)

The accounts can also be transferred to another family member or individual if, for instance, a beneficiary doesn't ultimately go to college—so savers don't have to worry their investments will go to waste.

Additionally, the plans, which are administered by states and educational institutions, also offer other state-specific benefits.

Still, not all 529 plans are created equal. Some plans have come under fire for not delivering a return to savers when compared to the returns on standard investment vehicles like mutual funds, which has led to investment outflows in some state plans.

And in 2011, the state of Nevada was found to have tapped its 529 plan savings to fill a budget shortfall, drawing the ire of 529 plan owners and consumer advocates.

Still, despite the concerns, experts say that the benefits of 529 plans continue to outweigh the risks.

According to a study published last month by investment research firm Morningstar, "college savers are continuing to invest in 529 college savings plans at an impressive clip."

The total savings in 529 plans grew 25 percent in 2012 to $166 billion—a record—surpassing the growth of investment in standard index funds and mutual funds for the year.

(Read More: So Your Kid Wants a Credit Card. What Do You Do Now?)

Indeed, the rate of 529 plan investments far exceeded the rate of inflows into the S&P 500 Index last year, which saw a 16 percent increase.

Nationwide, Morningstar found that the state-sponsored 529 plans with the best "risk-adjusted returns" were Maryland's College Investment Plan and New York's 529 Program.

The 529 savings plans of Rhode Island and Minnesota were found to be the most risky, according to Morningstar's analysis.

While 529 plans have underperformed the gains of standard mutual funds, the savings from the tax incentives can be a boon for savers. And the costs associated with enrolling in the plans have decreased as the variety and competition among plans have risen.

"Despite the continued market downturn from the recession, investment in 529 plans reached record levels in 2012," said Fitzgerald. "We're continuing to see families commit to investing in 529 plans as an easy and accessible alternative to borrowing and becoming saddled with student loan debt."

Ultimately, said Edward Jones' Dosmann, "pursuing higher education continues to be a lifelong goal for millions across the country, and by saving early and often, we can help our children graduate with less—or even no—debt."

—By CNBC's Jermaine Taylor. Follow him on Twitter @J_D_Taylor.

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