Episode 13: Revenue Sharing

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Welcome to Revamping Retirement, a podcast brought to you by Cammack Retirement Group, where we tackle the retirement plan related issues plaguing fiduciaries and plan sponsors. Our host, Mike Webb, has more than 25 years of experience in the retirement plan industry and is a nationally recognized subject matter expert. We hope you enjoy Revamping Retirement.

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Thanks Kara and welcome everyone out there in Podcastland to another exciting episode of Revamping Retirement. My name is Mike Webb and for the next 10 minutes or so we’re going to hopefully shed a little light on a topic that’s very confusing to lot of plan sponsors and participants and that is revenue sharing.

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And some of you don’t tune out right away. know some of you are going, revenue sharing, oh, wonderful. The most boring topic ever. But I promise here at revamping retirement, we’re here to make it exciting. And to start things off, we’re going to have a trivia question. And the trivia question has to do with a type of revenue sharing called 12B1. If you don’t know what 12B1 is, try to play along anyway. It’s a four-part guess. There’s an element of revenue sharing called 12B1.

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That was a special element of revenue sharing that was carved out. There’s other types of revenue sharing as well, but there’s a type called 12B1 which is probably the most notable. When were 12B1 fees invented? And the answers are A, 1970, B, 1980, C, 1990, or D, 2000. So one of those four. Take a guess and we will have the answer at the end of our revamping retirement podcast. Podcast number 13.

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which means for those of you who are keeping score at home,  then yes, we have survived a year of doing the Revamping Retirement podcast. Back on February 21st, 2019. We started off with our debut edition of Revamping Retirement and we thank all of you listeners out there who’ve been there since day one on the journey and also to our new audience out there, for those of you just joining us for the first time. For those of you joining us for the first time, by the way, if you want to pick up from the beginning,

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or anywhere along the journey. You can check out our website at www.cammackretirement.com Without further ado, let’s get into revenue sharing. Those of you think this is going to be boring, I promise it will not be. But I think it’s really important that people understand what revenue sharing is. It’s a major component of a lot of retirement plans and plan sponsors and participants should understand what it is, how they can control it. So what is it?

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It’s a fee, start out, it’s a fee. It’s not an added fee, a little bit of a misnomer, it’s a fee that’s included usually in the underlying expense of the investment. So for example, if a mutual fund has charges, a hundred basis points or 1%, this is part of that fee. So if there’s 25 basis points of revenue sharing, it’s not now that the mutual fund is 125 basis points. It’s not an added fee. It just means that of that hundred points, 25 is revenue sharing. Where does that revenue sharing go?

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it goes to the record keeper. And why does it go to the record keeper? Well, if I’m a mutual fund and I’m on a record keeper’s platform, a retirement plan record keeper’s platform, I don’t have to do a whole lot of stuff now. So say I’m Vanguard and I have a fund or multiple funds in the XYZ 401k plan. Well, now Vanguard no longer has to communicate directly with the participants, except in very limited ways. They don’t have to provide statements directly to the participants.

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They don’t have to have a website directly to the participants. That’s all taken care of by the record keeper. All those things cost money. So what Vanguard—the mutual fund company—then does, is they’ll take that revenue sharing and pay that to the record keeper in exchange for all these services the record keeper’s providing. You’re not getting something for nothing. You’re paying that fee to the record keeper. Now, ironically, some funds don’t pay revenue sharing and Vanguard is the largest fund company that doesn’t pay revenue sharing.

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But most mutual fund companies do, and they will pay revenue sharing directly to the record keeper. It can take various forms, but for the purpose of our 10-minute conversation, it’s all revenue sharing, whether you see it identified as 12B1 or sub-TA or distribution fees. It’s anything for our purpose that’s paid by a mutual fund company to a record keeper to offset costs that the mutual fund company would normally be paying. So it’s not an added fee. Why is it bad? What does it have a bad reputation?

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retirement plans. Well, if it didn’t exist, the idea is that funds would be less expensive. But actually, that’s not really the case. And I can tell you that a lot of games out there are played with this revenue sharing. And I’ll give you the example. Big major fund company out there, won’t say the name, has a fund that is, let’s say it’s 115 basis points. And they share revenue of 40 basis points. So that’s one share class of the fund. This mutual fund provider happens to have multiple share classes.

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So they have share classes from 40 basis points and they have higher ones of revenue sharing all the way down to zero. Well, you say, hey, you know what? I don’t want revenue sharing in my plan. I want to get it down to zero. Well, that particular fund, this is an actual example. Their zero revenue sharing fund is only a hundred basis points. So what happens is, is that the actual net cost of the fund is a hundred minus zero, a hundred. The net cost of the fund with the revenue sharing, net of revenue sharing is 115 minus 40.

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or 75. So the revenue sharing fund is actually cheaper net cost than net of revenue sharing. And why is that important? Because in a lot of plans right now, the plan sponsor recaptures that revenue sharing. It goes in what’s called the revenue credit account, which gets used for plan expenses or goes back to participants. So as you can see, that makes a great deal of difference. If I go to the zero revenue sharing class, I’m actually costing participants more money because that zero revenue share is 100 basis points.

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Whereas the 115 basis point fund that has 40 basis points in revenue sharing, I’m taking that 40 and giving it back to reimburse plan expenses, which basically is helping participants, or I’m actually giving that directly back to participants. So I have situation that the fund with the revenue sharing is actually cheaper than the fund without the revenue sharing. So you can see it can become complicated. But in a lot of cases, that’s not the case. And the fund with no revenue sharing is either the same net cost or it’s even cheaper. So…

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It does make a lot of sense in a lot of plans to try to reduce the amount of revenue sharing that you have in your plan. With that example like mine where you don’t want to give money back to the mutual fund providers, if you’re recapturing revenue by having a zero revenue share fund, it’s actually more expensive on a net basis. What’s wrong with revenue sharing fundamentally? Even if I can make revenue sharing work in my plan because I can get a fund that shares revenue, it’s a lower net cost. The problem is that participants don’t understand any of that. Two-thirds of participants still think it’s free, either in the retirement plan.

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So imagine trying to tell them, oh, by the way, there’s this little part of the fee for the mutual funds pay the record group for the privilege you did. You lost it before I even get to explain that. It’s been the subject of litigation, lots of litigation specifically over revenue sharing. And finally, the one other bad thing about revenue sharing is it creates a situation in a lot of plans where participants aren’t paying the same amount. For example, Vanguard funds, which don’t pay revenue sharing. Well, think about it. If I’m in a plan with a Vanguard fund,

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and the record-keeping fee is 30 basis points to run the plan and Vanguard doesn’t pay anything towards that, well then I’m getting all the plans record-keeping services are free if I’m 100 % Vanguard funds. Whereas the person who’s in a revenue sharing fund and pays 40 basis points, they’re paying the full brunt of the record-keeping fee for the people who are in Vanguard funds who didn’t pay the record-keeping fee. So it creates a fee in equity and record-keepers are on to that and they’ve created what’s called fee levelization—it levels the fee based on

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how much participants actually pay, but it’s not exact science and people can never understand that either. So in an ideal world in revenue sharing, what you would have is zero revenue sharing, participants get charged every fee directly to their accounts. And that does happen in a number of large 401k plans, but that’s not the predominant model right now. So in a nutshell, hard to communicate. It’s this layer of fees that people can’t understand and it creates fee inequity among participants.

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So my personal thoughts are hopefully it won’t be around 10 years from now and we won’t be having these conversations. But for now, plan sponsors should be aware of it, should be making sure they’re capturing it back to the plan as much as they can. Participants should be aware of it and aware that you’re not getting your 401k and 403 and 457 plan for free folks. You have to pay the piper. So if you’re not seeing a fee charged directly on your statements, chances are the funds you are in have revenue sharing, which makes them more expensive generally.

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and you’re paying through the fund. There’s no such thing as a free retirement plan. Well we’re about out of time. Want to get back to our trivia question. 12b-1, which is a component of revenue sharing. Probably the biggest one. When was that invented? Either 1970, 1980, 1990 or 2000. The answer is 1980. So give yourself a big clap if you got the answer to the question right. For Kara McCauley and our entire production team, I’m Mike Webb and this has been

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Revamping Retirement.

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The content in this podcast is for institutional investors and plan sponsors. The information is intended to be educational and is not tailored to the investment needs of any specific investor. All examples of investor gains and losses are hypothetical and intended to illustrate the importance of early saving and consistent retirement contributions over time. Investment decisions should be based on an individual’s own goals, time horizon, and risk tolerance. Nothing in this content should be considered as legal or tax advice and listeners are encouraged to consult their own lawyer.

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accountant or other advisor before making any financial decision. Thank you for listening to Revamping Retirement.