The Lowest Share Class Debate

401(k) plan fees have long been a focus of headlines and regulatory actions, resulting in disclosure documents and showing up in lawsuits. Revenue sharing is a practice of using some of the fees built into expense ratios of the investments to offset the cost of the plan. But, is that a good thing to do? Let’s examine this further.

Here’s a sample of how expense ratios and revenue sharing break down in an investment option with information obtained from their prospectus. (Note! In the corporate retirement plan world, investors purchase at net asset value (NAV), so sales charges are not applicable in our scenario here.)

Mutual Fund A share

Total annual fund operating expenses: 0.93%

Revenue sharing (as part of the total expense above): 0.50%

Mutual Fund R-6 share

Total annual fund operating expenses: 0.52%

Revenue sharing: 0%

In the retirement plan, sponsors have the choice to use the A share or the R-6 share in their investment lineup. The A share would provide 0.50% in revenue sharing payments to offset the cost of the plan. The R-6 won’t.

Where using the A share can be a problem:

Not all investments provide the same amount of revenue sharing offset. Maybe it’s zero or 0.10% or 0.35% at another fund company. It’s possible for every investment option in a plan’s lineup to have a different revenue sharing payment unless someone is paying attention and reviewing the lineup specifically for this.

This also means that if a participant somehow selects all the investments with lesser or no revenue sharing for use in their account in the plan, they won’t be paying their fair share toward plan costs. Their account very well could be subsidized by other employees. That’s not fair either.

The plan sponsor can fix this problem by stripping out all the revenue sharing from the plan and use “Zero-revenue sharing” funds like you see in the example above. These types of share classes don’t have revenue sharing built in, so there’s no worry of unequal revenue sharing payments.

Where using the A share can be an advantage:

The A share can actually be the best option for a plan under the right conditions, that is, if the plan sponsor works with a recordkeeper that can credit back the revenue sharing amounts to the participant accounts based on the investments they use. This can work really well, especially in the above scenario, where the result can be a less expensive fund for the participant once everything has been credited back. Check the math:

A share

Total annual fund operating expenses: 0.93%

Revenue sharing: 0.50%

Net expense after revenue sharing credited back: 0.43%

R-6 share

Total annual fund operating expenses: 0.52%

Revenue sharing: 0%

Net expense: 0.52%

Result: 0.43% is less expensive for a participant than 0.52%. It’s the same investment option, but participants who use it will pay less if the revenue sharing is credited back to their account.

However, not all recordkeepers have the capability to credit back the revenue sharing amounts to the participant accounts based on what they use.

Whichever way you decide to go with how you use revenue sharing or not, make sure that:

  1. You know what you’re paying for the plan and how

  2. You know your options for how the plan can be paid for

  3. You’ve documented your review and your decision

Need help? Let us walk you through this exercise and help you benchmark your fees.

Courtenay Shipley