With the release and subsequent repeal of the Department of Labor’s fiduciary rules for financial advisors dealing with client retirement accounts, much of the focus in recent years has been on the impact on advisors who provide advice to clients for their IRA accounts. Long before these rules were unveiled and then repealed, financial advisors serving 401(k) plan sponsors have had a fiduciary responsibility to act in the best interests of the plan’s participants under the DOL’s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 most 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 |
| R1 | RERAX | 1.58% | $15.80 | 23.86% | 9.51% | 11.22% |
| R2 | RERBX | 1.56% | $15.60 | 23.89% | 9.52% | 11.24% |
| R3 | RERCX | 1.12% | $11.20 | 24.43% | 10.02% | 11.74% |
| R4 | REREX | 0.81% | $8.10 | 24.81% | 10.35% | 12.08% |
| R5 | RERFX | 0.51% | $5.10 | 25.19% | 10.69% | 12.42% |
| R6 | RERGX | 0.46% | $4.60 | 25.27% | 10.74% | 12.47% |
3-and 5-year returns are annualized. Source: Morningstar Data as of 12/31/2020
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 advisors 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:
R1 1.00%
R2 0.75%
R3 0.50%
R4 0.25%
R5 and R6 have no 12b-1 fees.
Growth of $10,000 invested
The real impact of expense differences can be seen by comparing the growth of $10,000 invested by a hypothetical investor on December 31, 2010 and held through December 31, 2020.
- The $10,000 invested in the R1 shares would have grown to a value of $19,580.32.
- The $10,000 invested in the R6 shares would have grown to a value of $21,880.57.
This is a difference of $2,300.25 or 11.7%. The portfolios of the two share classes of the fund are identical, the difference in performance is due to the difference in expenses for the two share classes. If you think of these as two retirement plan participants, one whose plan uses the R1 share class and the other whose plan uses the R6 share class, the first investor would have 11.7% less after ten years due to their plan sponsor’s choice regarding which fund share class to offer.
This analysis assumes a one-time investment of $10,000 and the reinvestment of all distributions. Morningstar’s Advisor Workstation was used to perform this analysis.
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 salesperson. This is fine as long as that salesperson is providing a real service for their compensation and is not just being paid to place the business.
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 due to the extremely high expenses charged by these share classes. 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 quite pricey for a retirement plan in my opinion.
To be clear, I’m generally a fan of the American Funds. Overall however, their funds tend to offer a large number of share classes between their retirement, non-retirement and 529 plan shares. While the overall portfolios are generally the same, it’s critical for investors and retirement plan sponsors to understand the differing expense structures and the impact they have on potential returns.
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I personally don’t think too fondly of 401ks. I think it’s a scam, because there are so many restritions on them that most people lose money on their 401ks.
Tony thank you for your comment. Unfortunately I hear far too many comments like this about 401(k) plans. From looking at your excellent blog it looks like you live in Toronto, I’m not familiar with the Canadian equivalent to the 401(k). 401(k) plans themselves are not the problem, though there are too many plans out there that offer lousy, overpriced investment choices. However, like any investment account, the ultimate success or failure for a plan participant will fall to how much they have saved for retirement and how they’ve chosen to invest their money. I have a number of clients who have accumulated enviable amounts in their accounts for retirement. On the other hand I see much confusion out there among participants on how much they need to save and how they should allocate their investments. The Pension Protection Act of 2006 has made it easier for employers to offer advice to their participants and hopefully over time this will happen to a greater extent.
Tony, I’m all about the numbers. An expense ratio of 1.6% isn’t just bad, in my book, it’s criminal. After the last decade, we might agree 8% might be a welcome return for the next ten years. 1.6% is 20% of that. Only they’ll take the 1.6 regardless of whether the market is up or down. In retirement, most planners recommend a limit of 4% per year withdrawal rate. Imagine withdrawing your $80K but handing over $32K every year?
My company 401(k) expense is .05%. 2% over a 40 year career. That, I can live with.
Thanks for your comment Joe. While I am not totally an indexer its high fees like this that make me question active management on a regular basis.
from your article – would these fees be taken out on the total in a fund on an annual basis – for example you have $10,000 total in an R3 fund – would the 12b fee alone be $500 for that year?
R1 1.00%
R2 0.75%
R3 0.50%
R4 0.25%
R5 and R6 have no 12b-1 fees.
Bill thank you for your comment and for visiting the site. The answer to your question is yes. As a review in case you are not familiar with how 12b-1 fees work, they are a part of the overall expense ratio. Using the R3 shares as an example the overall expense ratio is 1.13% of which the 12b-1 fees of 0.50% are a part. Contrast this with the R6 shares that carry no 12b-1 fees with an expense ratio of 0.50% and you can see that the 12b-1 fess comprise most of the difference in the expense ratios between the two share classes. Also, typically the expense ratio is taken out of the gross returns on a daily basis by most fund companies, I’m not sure exactly how the American Funds does this.
Rodger is selfserving and not objective in any thing he write on this site!
Jeff thanks for your comment. Two things, there is no “d” in my name. Also I’m curious as to exactly what you find self-serving. As far as not being objective, part of a good blog is an author who expresses his/her opinion, guilty as charged. Lastly perhaps an “s” at the end of the word write would have been a better use of the English language.
Well crafted post Roger showing this scam to be what it really is: a ripoff for plan participants.
Thanks for your comment Steven. In my opinion any plan using the R1,R2,or R3 shares is being ripped off and should be asking why they aren’t in lower cost shares or should be looking at another arrangement.
Thanks for this story, Roger. My small company uses American Funds and are presently stuck in the R2 fee range. Do you have any advice on how a small company can move toward R5 or R6? Obviously we can grow our deposits over time – but being small limits the rate of growth — are there options with others that aggregate across clients to reduce fees or other fund managers with lower fees for a company w/ only $1-2M in total deposits?
Thanks,
Bruce
Bruce thank you for your comment. Once a plan moves above the $1 million mark in assets you have a few more options, though the choices are more limited than for plans with say $5-$10 million. The use of R2 shares could be for several reasons. It could be driven by the plan administrator to cover their costs/achieve the desired profit margin. Likewise it could be driven by the rep/advisor on the plan and their desire to be paid at a certain level.
Perhaps the main question that I have is why bother trying to get into a better American Funds share class at all? I’m not knocking the American Funds, but there are many other alternatives that can be looked at. Perhaps this is a good point in time to look at another platform as well. One thing that makes a plan more or less attractive to providers is average balance per participant. Let’s say plan A has $1 million in assets and 200 participants. With an average balance of $5,000 per participant and would not be very attractive or profitable. Let’s look at plan B with the same $1 million, but with 25 employees. Plan B is much more attractive to providers with an average balance of $40,000 per participant.
Hope this helps, please feel free to contact me directly with any questions or if you’d like to discuss.
My small firm is also in AmFunds in R2 class. With limited participants (3), and limited assets, I was lead to believe there were few to no choices for me when initially selecting a fund to host our 401k. Honestly, I couldn’t find another company who even offered anything to a small business.
I don’t anticipate having millions any time soon, but now that we have 5 participants with ~$300K in assets, do I have more choices?
I wasn’t aware that I have control of share class. I was told it’s up to the deal my advisor has with AmFunds. Can I “demand” lower fees? Or must we have much higher assets?
If indeed there ARE other choices to move our 401k to, I’d appreciate names of alternatives.
Appreciate the info.
Thanks for the comment Jim. On the one hand the total asset pool is small but your average balance at $60,000 would be pretty attractive to some administrators. I’d be glad to discuss with you please feel free to contact me https://thechicagofinancialplanner.com/contact/ offline if you are interested in some thoughts. Technically you don’t have control over the share class used and you are right that your advisor does. With R2 share it’s likely more money is going into his/her pockets, at the very least ask them why your plan can’t be in R4 or better shares.
So, this advisor is ripping off the plan by getting $3,750 a year before expenses this year, but 5 years ago received a few hundred before expenses. It would be great if advisors worked for free, but most people want to get paid. I would agree that a multi-million dollar plan should not be in R2 shares, but to say any plan in R2 is getting ripped off is absurd, and is misleading to your readers. This plan 5 years ago probably had $40,000 in it, the fee that year was $300, before any expenses (broker dealer fee, administrative support, travel to meet with client (probably multiple times), meet with employees, follow-up with plan compliance, etc. Should it be free?
Bill thank you for your comment. I agree that small plans can be tough to service and place with a low cost provider. But even three years ago when I wrote that piece there were lower cost TPAs and platforms out there where no participant should have to put their hard-earned money into an R2 share.
Roger- this is the problem. Employers want to offer an attractive benefit they generally they do not want to pay for. Employers generally do not have the time (or expertise) to do all the things that they need to do to manage and administer the plan. Many employees have no clue on investing and need help to make smart choices with their money. If the employer fails to give them the tools necessary to make smart decisions, the employer is liable for damages. So someone has to pay for an adviser (hopefully a good one) to assist in educating the employees and running the plan.
American funds is a very good company with excellent performance and great manager tenure. They offer different share classes because it gives the adviser the ability to price a plan based on the work involved and the total assets in the plan. A R-2 share class that has an advisory fee of .75% may look high, but is the plan has $500k in assets, the annual advisory fee is $3,500. If you do two employee meetings, and two trustee meeting annually, plus all the calls and prep-work, the adviser is not making a killing on your plan.
Fee disclosure is great and I am glad that it is now required. The problem is not American Funds, or the share class system. It is a matter that everyone wants something for nothing…both employers and employees. It costs money to administer and run these plans, and as long as you have a good adviser that provides value to the employees, the benefits far outweigh the costs!
Jerry thanks for your comment. I agree that the American Funds are by and large a good fund group and have solid fund managers and researchers. The article was not meant to disparage them (and I don’t think that I did that) but rather to illustrate the impact of share classes on costs. American Funds is the easiest to use with their multiple retirement share classes.
Clearly in the advisory situation that you described the $3,500 fee is a bargain. However for every advisor like yourself there are others in the commissioned space who don’t do much more than “place” the business.
I am fortunate that all of the plans sponsors whom I advise feel that my services are worth covering from company vs. plan assets. I also realize that not all sponsors have this mentality.
If you chose R6 shares, how do you get compensated if there aren’t any 12b-1 fees?
Hopefully if you are advising the plan you are charging a fee of some sort for your services.
Right. If you’re charing the average 1%, fee, than your total expenses brings the cost up much higher than some of the other share classes which already have compensation included (albeit, probably not a 1% 12b-1 comp).
Andreas thank you for your comment. I’m not sure if you are in the business of providing advice to 401(k) plan sponsors but I can’t imagine anyone charging 1% for doing this except for maybe very, very small plans. Typically for larger plans an advisor might charge 25 basis points or perhaps a flat consulting fee. The point is an advisor charges for objective advice that is hopefully agnostic of the funds or share classes used.
A well crafted and administers 401-K program offered through your employer can be one of the most useful tools for building up your retirement savings. It need not be the ONLY tool in your tool kit. A ROTH savings / investment plan allows you to stash after tax dollars, never having to worry about taxes again, when used correctly.
That said, costs matter in a 401-K, or ROTH account. Over 25, 30, 35 years your account balances can be eaten by nearly the same percentages as your years of contributions! That is cumulatively, year after year your balance 25% 30% 35% lower as the relentless impact of FEES in both good return years, as well as not good return years.
Feeding the account also matters, getting started early is better than later, and later is better than never. Feed it well, nobody gets there without hitting double digits in their contributions, do they?
I was fortunate, my employer had very low cost INDEX funds available, not a wide variety in fact only 5 in total. 25 years working there allowed saving & growing enough, along with the company 4% match up to 5% of earnings to create a large enough “egg” to allow a good retirement. Now 5 years into it, the balances are larger than when we embarked on this journey. Your mileage may vary.
JP thanks for your comment. Low fees and expenses are a vital part of the equation as is contributing as much as possible on a consistent basis.
I believe that the fiduciary rules for financial advisors allows for biased guidance and conflicts of interest. It doesn’t even guarantee loyalty to the client, disclosure or anything else. And with regards to the share classes, I don’t mind alloting funds for the sales person if he is worth the cost. But if the budget utilized for them are not worth it, it is obviously a waste of money.
Nick thanks for your comment. This biased guidance does need to be disclosed and plan sponsors could find themselves liable for breach of their fiduciary duties by allowing the use of funds that are more expensive than they need to be.
I believe people who make blanket statements without the correct facts do a great disservice to my industry and the people they are pretending to help. I have recently review this article because one of my client ask my opinion on the article and questioned why I was purposing the American Funds R-3 plan when the author of this article does not like the plan. I had to respond to my client that I thought the article was poor journalism.
The author’s analysis only compares the returns of one of the American Funds investment options, the EuroPacific Growth Fund and made the ridicules statement that share classes for any of the American Funds “would offer similar relative results.” This is not a true statement. To say the US stock market has performed like the Euro-Pacific stock markets over the past three and five years is bull. The last six or more years have been one of the worst performing times for the European stock market. Second of all no one in my client’s firm was invested 100% in the Euro-Pacific stock markets and when we compared the actual funds held by my client, his partners, and staff to similar funds within American Funds, Vanguard, John Hancock and other options offered by Fidelity and Lincoln. The majority of the time, the American Funds had beaten their performance. Therefore, I find his analysis bull.
The article states that using the R1, R2, and R3 shares have traditionally been used in plans where the 12b-1 fees are used to compensate a financial sales person and goes on to state that these fees are “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,” but make no allowances for this in his conclusion that you are in a “lousy plan.”
However, his big flaw in his reckless blanket statement “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” are his use of only on of American Funds most expensive mutual funds, comparing it performance to all of the American Funds performance, and not understand the American Funds fees structure. The more I look at this article the madder I got. I don’t understand how people claiming to be adviser can make such blanket stupid statements. Statements based on one funds fees and performance and make blanket statements about all of the American Funds performance. The EuroPacific Growth Fund is in one of the worst performing class in the last several years and an asset class that generally has the highest manager fees. He has also did not taken into account the fee credit granted by the American Funds which reduced the overall fees of the plan. In my clients plan this credit reduced the cost by 0.29%. These two factors in his analysis leads my client to believe that the overall plan costs are the American Funds R-3 plan is 1.13% when the actual plan’s expenses are only 0.91%. This overstates the fees by approximately 20%.
My conclusion is that you should be care of what is written or placed on the internet. It is often not true or is an analysis written to support the authors conclusion and not supported by facts.
Thank you for your comment Brendan. I will agree that the R3 shares can have merit in some cases, I was made aware of one such instance by an advisor who is using them with a 401(k) client and from what he described to me is serving that client admirably. I am also a fan of the American Funds as family and the EuroPacific fund as a core international holding.
That all said I’m pretty confident that if you did an analysis of the six retirement share classes for any American Funds choice you would find an inverse relationship between the cost of the fund and the fund’s results. The R1 shares will always have under performed the R6 shares due to the cost differences.
I think the fact that your plan sponsor client was questioning the use of the R3 shares is a good thing and they have a responsibility to the participants in the plan they offer. Assuming you have a good reason for proposing the R3 share class I fail to understand the problem. If you are hindered in providing advice to a plan sponsor by something I wrote you likely need to step back and reevaluate your explanations, the way in which you present information to your clients and perhaps your relationship with this client.
The point of this article was to illustrate the differences in costs for different retirement plan share classes of a given fund to the reader and to urge them to actually read the annual 408(b) disclosures that they receive. The American Funds with their six retirement plan share classes lends itself well to this type of analysis.
It feels like you are looking for a scapegoat for your difficulties in communicating with your client. Good luck to you especially as the new fiduciary rules are phased in.
I have no problem communicating with my client. I have a problem with your blanket statements. Statements that are not based in fact and skew the analysis to the point you are try to make and does not mention fees reimbursements that the American funds offer. Statements such as:
1. 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.
2. 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.
3. 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.
I have problems with blanket statements. I have no problem relating to my client because we have performed an analysis and obtained quotes from John Hancock, American Funds, Lincoln (only using Vanguard index Funds), Lincoln using all available funds, Fidelity and various other plans. In addition, our analysis include a review of the funds performance and we did not conclude that the American R3 Fund often had “mediocre to poor performers” like you have stated. American R3 was determined to be the best proposal, but your conclusion without any real analysis and without any real facts stated it was a lousy plan.
My employer plan is currently with American Funds and R5. So due to the performance and decreased fees with R6, what is the advantage of staying with R5? Why would they have decided R5 vs R6? Have R6 shares been available as long as R5?
Thanks for your comment. As a participant the difference is pretty negligible, I would consider a plan using the R5 share class to be one that is “doing right” by their participants. Neither share class has 12b-1 fees, there might be some differences in shareholder servicing fees collected by the plan platform.
How can you make this comment, 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” when the fact show the followin:
Expense 1 yr 3 yr 5 yr
R3 EuroPacific Growth Fund 1.13% $11.30 -10.13% 2.24% 1.37%
R6 Am 2010 Target Date 0.46% $4.60 1.50% 8.17% 9.08%
R6 Am 2015 Target Date 0.46% $4.60 1.84% 8.17% 10.01%
R6 Am 2020 Target Date 0.48% $4.80 2.38% 10.95% 11.20%
R6 Am 2025 Target Date 0.50% $5.00 2.56% 13.07% 12.86%
R6 Am 2030 Target Date 0.52% $5.20 3.81% 14.31% 13.74%
R6 Am 2035 Target Date 0.53% $5.30 4.08% 14.61% 13.91%
R6 Am 2040 Target Date 0.53% $5.30 4.07% 14.84% 14.06%
R6 Am 2045 Target Date 0.53% $5.30 4.25% 14.89% 14.08%
R6 Am 2050 Target Date 0.54% $5.40 4.23% 14.87% 14.09%
Now I know the returns on the R3 shares a little less, but their returns have no similarity to the EuroPacific Growth Fund and it is in my opinion almost malfeasance to imply they do…or to imply that the American Funds Returns are “often mediocre to poor performers” when you analysis only related to the EuroPacific Growth Fund.
If you were not trying to skew your point…why didn’t you use the American Fund 2050 Target Date Fund with a 1 year return of 4.23%, and 3 year return of 14.87% and 5 year return of 14.09%…Instead you used the EuroPacific Growth Fund with a 1 year return of -10.13%, and 3 year return of 2.24% and 5 year return of 1.37% and then claimed that classes for any of the American Funds products would offer similar relative results…when in fact no other fund would have shown a -10.13% in the 1 year category.
Brendan first of all you clearly missed the point of this piece. The point is that plan participants should pay attention to the share classes offered in their plans. The use of EuroPacific Growth or ANY American Funds fund will illustrate the point that different share classes OF THE SAME FUND will have different results based upon the expense ratio. The results of this analysis would be the same if you compared the R1-R6 shares of their Growth Fund of America, any of the Target Date Funds, Amcap, Washington Mutual or any other American Funds offering that has the R1-R6 share classes.
The point is that I wanted to educate plan participants about the fact that mutual funds used in the plan offered to them by their employer might not contain the best (least expensive) share class available. Why would you object to this? Don’t you agree that plan participants (and sponsors) should be as educated about what is in their plan as possible?
Honestly if you are working in your client’s (both the sponsor and the participants) best interests why would you care what some insignificant little finance blogger like yours truly has to say?
Are you familiar with the research of Vanguard or even the SEC regarding the difference in participant outcomes (or those of any investor) from just a seemingly small difference in expense ratios?
Also I said the the R1 and R2 share classes were often mediocre performers. The American Funds and their parent Capital Group are a first class company and many of their funds, in the more advantageous share classes, are solid performers.
I’d be curious to know how big this plan is in terms of assets and what the aggregate overall all-in costs are as a percentage of assets. By all-in I mean administration, record keeping, expense ratios plus any asset charges that your firm may take from plan assets.
Roger I enjoyed your writing, thanks!
Josh thanks much.
I have heard of some brokers or investment places that will charge 5% of your total just to move your 401k to them. Is this true and if so which places are doing this and which places don’t charge a fee just to move your 401k balance. Please respond. Thanks Wayne.
Thank you for your comment. I have not heard of fees in that range, in fact I am surprised to hear of anyone charging a fee to rollover your balance. That said I wouldn’t be at all surprised if this did occur. Thanks for bringing this to my attention, I will do some research to see if I can find some examples of what you describe.
You could be referring to an upfront sales charge on an A share. That all depends on the amount being transferred over as that charge will decrease with larger amounts. That is not necessarily a bad thing as long as the funds are good and the advice is prudent. Since this discussion was somewhat around American Funds, if you moved over your 401(K) into an IRA with American Funds into the Growth Fund of America A – share (just as an example, not as a recommendation), your annual expenses going forward are very low compared to other managed mutual funds. If you work with a fee-based adviser, he will most likely charge an annual fee of somewhere around 1% (on top of fund fees and perhaps a platform or trading fee). This over the long run is more expensive to the client than a one time sales charge into an A share (using the above as an example). Again, not a bad thing but we’re also comparing a fee based approach to a commission approach. Some investors prefer one over the other.
Thank you very much for your helpful and informative article. I wish that this page was a number one Google hit when seeking the truth about the high cost of R2 shares. I have been looking carefully today at my 401K account statement as of December 31, 2018 and am not happy. My investment mix of American Funds R2 funds all show losses for the past year and high expenses. My SMALLCAP World Fund-R2 has an expense ratio of 1.80% and lost 10.38% over one year. My EuroPacific Growth Fund-R2 fund has an expense ratio of 1.57% and lost 15.85% over one year. It is clearly time for my employer to seek an alternative retirement plan.
Abbie thanks for your comment. The R2 shares have brutally high expense ratios, that do nothing for your returns. Hopefully your employer will see the light and at least use lower cost classes shares of these funds.
Since plan sponsors are legally fiduciaries and required by !aw to put p!an participant’s best interests first, why are there even 6 levels of R shares with varying levels of 12b-1 fees?
Thanks for your comment Jim. All good questions that I would defer to you on given your industry and legal background.