Changing Share Classes: A Strategy for Reducing Retirement Plan Investment Costs

When managing a retirement plan, fiduciaries are always on the lookout for ways to minimize costs and maximize returns for plan participants. One often-overlooked strategy to achieve this is by changing the share classes of the mutual funds offered within the plan. Understanding what share classes are, and how switching between them can reduce investment costs, is crucial for maintaining a plan that serves the best interests of its participants.

What Are Share Classes?

Mutual funds typically offer different "share classes," which represent varying fee structures for the same underlying investment portfolio. The main difference between these classes is the expense ratio, which is the annual fee charged to investors to cover the fund's operational costs. These fees can include management fees, administrative fees, and sometimes distribution fees (also known as 12b-1 fees). Retail investors often access higher-cost share classes, such as Class A or Class C shares, which have higher expense ratios due to added fees like sales loads or 12b-1 fees [1]. On the other hand, institutional share classes, like Class I shares, are generally reserved for larger investments and come with significantly lower expense ratios, as they do not include these additional costs [2].

How Changing Share Classes Reduces Costs

Switching from a higher-cost share class to a lower-cost one can directly reduce the overall expenses of the retirement plan's investment options. For instance, if a plan is invested in a mutual fund's retail share class with a 1% expense ratio, and the plan switches to the institutional share class of the same fund with a 0.5% expense ratio, the savings on investment costs would be substantial. Over time, these lower expenses mean more of the investment returns are retained, leading to a higher account balance for participants [3].

The cumulative effect of lower expense ratios can be significant, especially when compounded over many years. A small reduction in fees can add up to a substantial difference in retirement outcomes. For example, a 0.5% reduction in fees over a 30-year period could result in tens of thousands of dollars more in a participant's retirement account, depending on the size of the investment and market conditions [4].

The Fiduciary Responsibility of Monitoring Costs

As a fiduciary, monitoring and minimizing investment costs is a critical responsibility. The U.S. Department of Labor has consistently emphasized that plan sponsors must act in the best interest of participants, which includes ensuring that the fees paid for investments are reasonable. One way to fulfill this duty is by regularly reviewing the share classes available in your plan's investment lineup and considering whether switching to a lower-cost option is possible and prudent [5]. This review should be part of an ongoing fiduciary process that includes benchmarking fees, assessing fund performance, and documenting all decisions related to the plan's investment options.

Conclusion

Changing share classes is a straightforward and effective strategy to reduce the investment costs within a retirement plan. By opting for lower-cost share classes, fiduciaries can enhance the retirement outcomes for participants by ensuring that more of their investment returns are retained. Regularly reviewing and adjusting share classes as part of a fiduciary process is not just a best practice—it's a critical component of fulfilling your fiduciary duties.

References:

[1] U.S. Securities and Exchange Commission. (n.d.). Mutual Fund Fees and Expenses. Retrieved from https://www.sec.gov/investor/pubs/sec-guide-to-mutual-fund-investing.html 

[2] Morningstar, Inc. (2021). Understanding Mutual Fund Share Classes. Retrieved from https://www.morningstar.com/articles/understanding-mutual-fund-share-classes 

[3] Bogle, J. C. (2019). The Little Book of Common Sense Investing: The Only Way to Guarantee Your Fair Share of Stock Market Returns. John Wiley & Sons.

[4] Vanguard Group. (2020). How Expense Ratios Affect Returns. Retrieved from https://www.vanguard.com/how-expense-ratios-affect-returns 

[5] U.S. Department of Labor. (n.d.). Meeting Your Fiduciary Responsibilities. Retrieved from https://www.dol.gov/sites/dolgov/files/ebsa/about-ebsa/our-activities/resource-center/publications/meeting-your-fiduciary-responsibilities.pdf 

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