Mutual Fund Share Classes and Your 401(k)

The same funds can cost you very different amounts.

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Roger Wohlner

The recent fee disclosures for the investment options in a company’s 401(k) plan may shed some unwanted light on some plan’s investment choices.

That’s because many fund families offer multiple share classes for their funds used in 401(k) plans, and those share classes come with different costs. While the underlying holdings of a fund may be identical, investor’s returns will vary based on the expense ratio of each individual share class.

Funds offered by American Funds, a staple in many 401(k) plans, are a good case in point. They offer six retirement plan shares classes, labeled R1-R6 (that’s in addition more than a dozen types of share classes offered for everyone from retail investors to those with college savings accounts).

For the firm’s popular EuroPacific Growth fund, R1 shares have an expense ratio of 1.61 percent which includes a 12b-1 fee of 1.00 percent, a fee designed to cover compensation of an adviser or a third-party administrator of the plan that’s included in the overall expense ratio.

Including those fees, the 3-year annual average return for the fund in this example is 2.55 percent. By comparison, the R6 shares have an expense ratio of just 0.50 percent and include no 12b-1 fee. Including those lower fees, the 3-year annual average return for the fund is 3.70 percent.

For reference sake, the 12b-1 fees by share class for the fund are:

  • R1 1.00%
  • R2 0.75%
  • R3 0.50%
  • R4 0.25%
  • R5 No Fee
  • R6 No Fee
  • In all cases the 12b-1 fees result in a higher overall fund expense ratio and lower returns for plan participants.

    In my opinion, any plan using the R1, R2, or R3 shares of this or any American Funds fund is overcharging participants. If you see these classes listed on your disclosure statement, ask the folks running the plan if it’s possible to move to a less expensive share class. If you run an organization offering a plan with funds like these, ask some pointed questions of your adviser and the plan service providers.

    While the American Funds are a bit unusual in the number of share classes offered, it is not unusual for there to be several choices of share class available for a 401(k) plan. Take the suite of target-date funds offered by T. Rowe Price. Using their Target-Date Retirement 2020 fund as an example, there are three share classes available with differing expense ratios:

    • The main share class has an expense ratio of 0.70 percent with no 12b-1 fee and a 3-year average return of 10.28 percent.
    • The ADV share class has an expense ratio of 0.95 percent with a 12b-1 fee of 0.25% and a three year average return of 9.98 percent.
    • The R share class has an expense ratio of 0.95 percent with a 12b-1 fee of 0.50 percent and a three year average return of 9.71 percent.
    • Those cost differences are important to understand. I happen to think highly of both the T. Rowe Price target-date funds and the American Funds EuroPacific Growth Fund (though this post should not be construed as investment advice). And various share classes are priced differently for a reason (some may be dictated by the size of a 401(k) plan’s asset level, or be priced according to how high investment minimums are set). In other cases, the share class used might be part of the compensation structure of a plan’s service providers.

      But both illustrate the need for both participants and sponsors to be cognizant of the share class offered by their plan for mutual funds with multiple share class options.

      Roger Wohlner, CFP®, is a fee-only financial adviser at Asset Strategy Consultants based in Arlington Heights, Ill., where he provides advice to individual clients, retirement plan sponsors, foundations, and endowments. Read more about Roger here.