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Why A, B, C funds are bad for your 401(k)
When you purchase a small business 401(k) plan, it’s important to learn all you can in “fund class.” If your 401(k) plan is built with mutual fund classes of A, B, or C, well you are probably paying more than you could have. It’s important to know that another option for 401(k) plans, Exchange-Traded Funds (ETFs), don’t have these “classes” as you consider all your investment options.
Understanding Fund Classes at a Glance
Class A, B, and C shares often have significant sales loads. It will either be a front-end load (a charge every time you buy into the fund), a back-end load (a charge when you sell the fund), or an on-going fee. In 401(k) plans, each paycheck employees contribute to their plan and purchase shares, so a front-end charge can really take a chunk of what you and your employees contribute. Same for when you sell a fund with a back-end load. This is why these fund classes can be particularly bad fit for 401(k) plans. Here’s the quick skinny on the differences:
||Front-end Sales Load
||Back-end Sales Load
||On-going Fund Expense
|Class A Mutual Fund
||Yes. Typically 3% to 5.75% of each new dollar invested depending on amount invested & provider.
||Typically lower than Class B and C. May impose asset-based charge around 0.25%.
|Class B Mutual Fund
||Yes. Tends to decline each year you hold it. May go to zero percent by year 6.
||Tends to have higher expenses than Class A but less than Class C
|Class C Mutual Fund
||Maybe. If so, it’s usually for shares held for less than 1 year and typically around 1%.
||These tend to have the highest asset-based fees. Asset-based charges are often around 1%.
||No. Note that transaction fees are waived in many ETF-based 401(k) plans too.
||Typically, much lower on-going expenses than actively managed mutual funds.
There is little to no difference in what stocks or bonds are held in a specific mutual fund that offers different class options, and why lower-expense, no load funds will be a better value for you and your employees.
How to ensure you have low-expense funds
For a 401(k) plan, Class I shares are designed for business customers and other institutions. These and ETFs tend to have lower fees with no loads compared to other classes. Class R shares are also common in retirement plans and typically have higher fees than Class I shares. Small businesses are often excluded from Class I options due to lower asset size versus larger company plans. For ETF-based plans, look for providers that waive ETF transaction fees as these add costs. Any asset management fee participants pay in an ETF-based plan will be clearly separate from fund expenses so you know what you are paying for. It’s one important reason ETFs are making in-roads into 401(k) pl