With the release of the Department of Labor’s fiduciary rules for financial advisors dealing with client retirement accounts, much of the focus has been on the impact on advisors who provide advice to clients on their IRA accounts. Long before these new rules were unveiled, financial advisors serving 401(k) plan sponsors have had a fiduciary responsibility to act in the best interests of the plan’s participants under the DOL’s ERISA rules.
Starting in 2012, retirement plan sponsors have been required to disclose the costs associated with the investment options offered in 401(k) plans annually.
As an illustration, here’s how the various share classes offered by the American Funds for retirement plans stack up under the portion of the required disclosures that deal with the costs and performance of the plan’s investment options.
American Funds EuroPacific Growth
The one American Funds option that I’ve used over the years in 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. The R6 share class is the least expensive of the retirement plan share classes. Let’s look at how the various share classes 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|
3 and 5 year returns are annualized. Source: Morningstar Data as of 4/30/2016
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. The 12b-1 fees by share class are:
R5 and R6 have no 12b-1 fees.
Share classes matter
The R1 and R2 shares have traditionally been 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.
With all of the publicity generated by the new DOL fiduciary rules one has to wonder if the expensive R1 and R2 share classes might go by the wayside at some point
If you are a plan participant and you notice that your plan has one or more American Funds choices in the R1 or R2 share classes in my opinion you probably have a lousy plan and you are overpaying for funds that are often 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. The R3 shares are a bit of an improvement but still pricey for a retirement plan in my opinion. That evaluation has to be made in the context of the plan’s size and other factors.
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