Low-Priced Share Classes: Why the Same Fund Can Cost Your Plan More

Picture two 401(k) plans that both offer the same large-company stock fund. Same managers, same holdings, same strategy. Participants in one plan pay noticeably more each year to own it. The only difference is the share class.

Share class selection is one of the least visible decisions in a 401(k), and one of the more straightforward to fix once you know where to look.

What a share class is

Many mutual funds issue several share classes of a single portfolio. Each class owns a slice of the same investments, but each carries a different cost structure. In retirement plans, you will commonly see:

• Retail classes, often labeled A or C, designed for individual investors and sometimes carrying sales loads
• Retirement classes, often labeled R1 through R6, with costs that typically decline as the number rises
• Institutional classes, often labeled I or similar, generally with lower costs and higher investment minimums

The differences in cost usually come from fees layered into the expense ratio: 12b-1 fees for marketing and distribution, sub-transfer agency fees, and other payments to service providers.

How revenue sharing works

Part of a fund's expense ratio may be passed along to the plan's recordkeeper, broker, or other providers. This is called revenue sharing.

Revenue sharing is not prohibited, and some plans use it to help pay administrative costs. But it creates several practical problems:

• It is hard to see. The cost is buried inside the expense ratio rather than shown as a separate line item.
• It is uneven. Participants in funds that pay more revenue sharing bear more of the plan's costs than participants in funds that pay less.
• It can create incentives. Providers may have reason to favor funds that pay them more.
• It grows on its own. Because revenue sharing is usually a percentage of assets, the dollars flowing to providers rise as the plan grows, even if the services do not change.

Why it matters

Fund expenses come out every year regardless of how the investments perform. A difference that looks small in a single year repeats year after year over a participant's career.

ERISA requires fiduciaries to make sure plan fees are reasonable. If your plan uses a higher-cost share class when an otherwise identical lower-cost class is available, you need a sound reason, and you need to be able to explain it.

What courts have said

Share class selection has been a recurring theme in 401(k) fee litigation.

In Tibble v. Edison International (2015), the U.S. Supreme Court held that ERISA fiduciaries have a continuing duty to monitor plan investments and remove imprudent ones. The case centered on a plan's use of retail share classes when institutional classes of the same funds were available.

In Hughes v. Northwestern University (2022), the Court rejected the idea that offering a broad menu, including some low-cost options, excuses fiduciaries from addressing imprudent options elsewhere in the lineup.

These cases involved large plans, but the principles apply to plans of every size.

Is the cheapest class always the answer?

Not necessarily. A few things can complicate the picture:

• The lowest-cost class may carry a minimum investment the plan cannot meet, though fund companies sometimes waive minimums for retirement plans, so it is worth asking.
• A higher-cost class with revenue sharing may be offset by a lower direct recordkeeping fee. What matters is the total cost of the plan relative to the services provided.
• Some plans credit revenue sharing back to participants through a fee leveling arrangement, which can address the fairness problem.

The goal is not to chase the lowest number on every fund. It is to understand what you are paying, why, and whether a lower-cost option for the same investment is available.

Collective investment trusts

Many investment strategies are also offered as collective investment trusts (CITs). CITs are maintained by banks or trust companies, are available only to qualified retirement plans, and often cost less than comparable mutual fund share classes. Not every platform offers every CIT, but they are worth asking about.

What to do

A share class review does not have to be complicated:

1. Request a list of every fund in your plan with its share class, ticker, and expense ratio.
2. Ask your recordkeeper which funds pay revenue sharing and how much.
3. Ask whether lower-cost share classes or CIT versions are available on your platform.
4. Compare the plan's total cost before and after any changes.
5. Document what you reviewed and what you decided.
6. Repeat the review periodically, since fund companies launch new share classes over time.

Want a second look at your plan's share classes? Brian Williams, CPFA®, of Northshire Consulting LLC | Registered Investment Advisory Firm meets with business owners to review plan investments and fees. Call 203-401-6062, email bwilliams@northshireconsulting.com, or visit northshireconsulting.com to schedule a plan review.

Frequently asked questions

How do I find out which share class my plan uses?

Your fund lineup or annual participant fee disclosure lists each fund's name and ticker symbol. The share class is usually part of the fund name, and the ticker identifies the class precisely.

If we switch share classes, do participants have to do anything?

Usually not. Your recordkeeper can typically move assets from one share class to another class of the same fund. Participants receive advance notice of the change.

Is revenue sharing illegal?

No. Revenue sharing must be disclosed, and the plan's overall fees must be reasonable for the services provided.

This material is for educational purposes only and is not individualized investment, tax, or legal advice. Advisory services are offered through Northshire Consulting LLC | Registered Investment Advisory Firm.