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401(k) Fee Disclosure and the American Funds


About two years ago I wrote what remains one of the most popular posts on this blog American Funds-The Secret Sauce for 401(k) Plans.  The point of the article was to look at 401(k) plans sold by many commission-based advisors to smaller employers consisting solely of mutual funds from the American Funds as investment options.

In light of the new disclosure requirements which will shed light on the costs associated with the investment options offered in 401(k) plans I wanted to take a look at how the various share classes offered by the American Funds for retirement plans would stack up under the portion of the required disclosures that deal with the costs and performance of the plan’s investment options.

The one American Funds option that I use in a couple of 401(k) plans is the EuroPacific Growth fund.  This fund is a core large cap foreign stock fund.  It generally has some emerging markets holdings, but most of the fund is comprised of foreign equities from developed countries.  I am able to use the R6 share class, the least expensive of the retirement plan share classes.  Let’s look at how the various share classes would stack up in the disclosure format:

Share Class

Ticker

Expense Ratio

Expenses per $1,000 invested

Trailing 1 year return

Trailing 3 year return

Trailing 5 year return

R1

RERAX

1.62%

$16.20

-6.98%

16.16%

-0.49%

R2

RERBX

1.61%

$16.10

-7.00%

16.14%

-0.52%

R3

RERCX

1.13%

$11.30

-6.52%

16.71%

0.00%

R4

REREX

0.85%

$8.50

-6.26%

17.04%

0.27%

R5

RERFX

0.55%

$5.50

-5.98%

17.40%

0.57%

R6

RERGX

0.50%

$5.00

-5.94%

17.43%

0.48%

3 and 5 year returns are annualized.  Source:  Fi360   Data as of 3/31/2012

Note the 3 and 5 year returns for the R6 share class are estimated by Morningstar as this share class just came into being in 2009.  On an actual participant disclosure report the 3 and 5 year numbers would be left blank. 

While the chart above pertains only to the EuroPacific Growth fund, looking at the six retirement plan share classes for any of the American Funds products would offer similar relative results.

The underlying portfolios and the management team are identical for each share class.  The difference lies in the expense ratio of each share class.  This is driven by the 12b-1 fees associated with the different share classes.  This fee is part of the expense ratio and is generally used all or in part to compensate the advisor on the plan.  In this case these would generally be registered reps, brokers, and insurance agents.  The 12b-1 fee can also revert to the plan to lower expenses.  In past years we have used the R4 shares of this fund and the 12b-1 fee went to lower the expenses for those participants investing in the fund.  The 12b-1 fees by share class are:

R1                   1.00%

R2                   0.75%

R3                   0.50%

R4                   0.25%

R5 and R6 have no 12b-1 fees.

The R1, R2, and R3 shares are generally used in plans where the 12b-1 fees are used to compensate a financial sales person.  This is fine as long as that sales person is providing a real service for their compensation and is not just being paid to place the business.

Plan sponsors (the employers sponsoring the plan) were supposed to receive disclosures from all covered service providers who receive any compensation from plan assets by July 1 which detail their compensation, the source(s) of their compensation, and the services they are providing to the plan.  It is my hope that any plan sponsor who looks at a disclosure from any financial advisor who has their plan in R1, R2, or R3 shares does a thorough round of due diligence to find out why their participants are in these expensive shares and what services the advisor is providing to justify receiving these hefty fees.

If you are a plan participant and you notice that your plan has one or more American Funds choices in the R1, R2, or R3 share classes, in my opinion you have a lousy plan and you are overpaying for funds that are generally mediocre to poor performers.  It is incumbent upon you to ask your employer if the plan can move to lower cost shares or even a different provider.

If you would like an independent review of your company’s 401(k) plan, please feel free to contact me.

Upvote (3)
Comment   |  7 years ago from Arlington Heights, IL