Calculating American Funds 401(k) Fees Using Their 408b-2

American Funds (“AF”) is the third largest mutual fund company in the US and a dominant provider of small business 401(k) plans. Their plans are loaded with proprietary in-house funds. While there is nothing inherently illegal or unethical about that, the situation could create a conflict of interest that results in an overpriced 401(k) plan. To confirm their 401(k) participants are not harmed by a conflict, employers must ensure their AF fees are reasonable. To do that, employers must be able to total them – so they can then be benchmarked against competing 401(k) providers. AF doesn’t make this job easy.

AF 401(k) fees are difficult to total for two major reasons. First, their 408b-2 fee disclosure isn’t tailored to each client. Instead, it’s a one-size-fits-all document that reports the fees a 401(k) plan would pay based on its assets, participant count, and share class (AF 401(k) funds are offered in six share classes – each paying different amounts of revenue sharing). Second, AF does not perform all of the major 401(k) administration services themselves. Instead, these services are performed by an unrelated partner. That means more service provider fees to account for.

If you’re an employer with an AF 401(k) plan, I want to help you total your plan fees – because I know you’re probably paying higher fees than you think. Below is the 3-step process I use to total AF 401(k) fees when comparing them to our fees. You can use the same process to total your plan fees. I’ll use an actual AF 401(k) plan with 20 participants and $517,949 in assets as a guide. Once done, you’ll be ready to evaluate the total cost of your 401(k) plan – including any hidden fees paid by revenue sharing - for reasonableness.

Step #1 – Confirm the AF 408-b2 covers all of your 401(k) fees

AF is considered an “unbundled” 401(k) provider because they don’t perform all three of the major 401(k) plan administration services - they perform asset custody and participant recordkeeping, but not third-party administration - basically, ERISA compliance. The missing service is performed by an unrelated Third-Party Administrator (TPA) partner. In the AF 408b-2, recordkeeping services are described in Exhibit A: Recordkeeping Services, while their custodian services are described in Exhibit D: Custodial Agreement.

In the AF 408b-2, financial advisors are defined as “Financial Professionals.” If your 401(k) plan hired a broker, their fees will always be covered by the AF 408b-2 because their compensation is paid by revenue sharing - based on the AF share class selected. If your advisor is an investment adviser, their fees will be covered by the AF 408b-2 only if they’re paid from your plan’s unallocated revenue sharing account – defined as the “Plan Expense Account” in section III.

In short, if your TPA and financial advisor (if applicable) are paid 401(k) fees in addition to revenue sharing, you’ll need to add their dollar total to the fees you found in your AF 408b-2. 

Step #2 – Total your 401(k) plan’s direct fees

“Direct fees” are the most transparent type of 401(k) provider fee. Their dollar amount must be reported in 408b-2 disclosures and reported in 404a-5 (participant) fee disclosures, plan statements, and Form 5500s when paid from plan assets.

AF direct fees are based on three factors – plan assets, participant count, and AF share class (R-2, R-3, R-4, R-5, or R-6). From Exhibit B of the AF 408b-2:

My 20-participant 401(k) plan with $517,949 invested in R-2 shares pays no AF direct fees. However, the plan sponsor claimed to pay $350.00 in annual direct fees to the plan’s TPA. 

Step #3 – Total the revenue sharing

Revenue sharing is much less transparent than direct fees. It can be estimated in 408b-2 disclosures, buried in the fund expense ratios of 404a-5 disclosures, and disregarded altogether in plan statements or Form 5500s. This lack of transparency makes revenue sharing payments easy to overlook.

However, overlooking the revenue sharing payments made by your 401(k) plan’s investment funds would be a mistake because it reduces participant returns just like direct fees – which means you have a fiduciary responsibility to keep them in check too.

To total AF’s revenue sharing, you must convert the revenue sharing percentages disclosed in your 408b-2 to a dollar amount. Below are the steps I take to do it:

• Enter the current balance for all plan investments into a spreadsheet.
• Enter the revenue sharing percentage applicable to each fund. This information is found in Exhibit C of the AF 408b-2.

• Multiply each fund’s balance by its revenue sharing percentage to determine the dollar amount the fund pays AF in revenue sharing.
• Sum the revenue sharing paid by all plan funds

Using a spreadsheet, I found my AF 401(k) plan example paid $5,697.45 in revenue sharing annually:

Don’t overlook revenue sharing when evaluating your 401(k) plan fees!

My AF 401(k) plan example paid $6,047.44 in annual fees – $350.00 in direct fees and $5,697.44 in revenue sharing. In other words, nearly all 401(k) fees were paid by revenue sharing. However, because these payments are based on a percentage of assets, their dollar amount can increase quickly when assets grow. By the time the plan hits $1 million in assets, the revenue sharing will nearly double to $11,000!

If your AF 401(k) plan pays revenue sharing, you overlook look these 401(k) fees at your peril – because these payments can easily result in excessive fees – especially as your plan assets grow. While it’s possible to total these fees, the AF 408b-2 disclosure doesn’t make this job easy. Too much trouble? You have an easy out. Just replace AF with a 401(k) provider that charges fully-transparent direct fees.