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Understanding and avoiding 12b-1 fees - 2023 update

David Ramirez, CFA
July 6, 2023
Understanding and avoiding 12b-1 fees - 2023 update
Table of contents

Avoiding 12b-1 fees is one of the most important ways employers can lower the cost of their 401(k) plan. Paying higher fees does not guarantee better performance, in fact, it could be the opposite.

“The grim irony of investing is that we investors… don’t get what we pay for, we get precisely what we don’t pay for. So if we pay for nothing, we get everything.”

-John Bogle, The Little Book of Common Sense Investing

According to a study published in 2023, 401(k) fees have decreased by more than 50% since 1996. Investors attribute this decline to opting for lower-cost funds that do not charge 12b-1 fees. But many 401(k) plans still include funds with unnecessary 12b-1 fees, resulting in unnecessary fee waste.

For example, in 2022, the average overall expense ratio of stock mutual funds was 1.03%. However, it is now common to find low-cost index funds with management fees as low as 0.05%. That is a nearly 1% fee difference, which can add up over time.

In this article, we’ll discuss what 12b-1 fees are and how to avoid them.  

What are 12b-1 Fees?

12b-1 fees are commissions paid to individuals or companies who promote and sell the fund in your 401(k) plan. These individuals or companies can include your advisor, broker, TPA, or 401(k) recordkeeper. Mutual fund expense ratios conceal the fee, making it difficult for mutual fund investors to determine how their retirement providers are paid.

Essentially, with 12b-1 fees, you and your participants (AKA the fund investors) are paying for the fund to acquire more customers.

About the 12b-1 fee and mutual funds:

In 1980, the SEC created rule 12b-1 under The Investment Company Act of 1940. It allows mutual funds to use shareholder investments to cover their operating expenses. They refer to them as a marketing and distribution fee, although they function as a sales commission.   In some instances, these fees may also cover non-distribution shareholder services.

Class A fund shares usually have a front-end load, while no-load mutual funds only charge a service fee. Class B and C shares, which have a back-end load, typically have higher 12b-1 fees.

How much is the average 12b-1 fee?

Total 12b-1 fee can vary, but it usually ranges from 0.25% to 1% of the average net fund assets per year. That might not sound like a lot, but over time it can add up to a significant chunk of change.

401(K) benchmarking guide. Download now.

Why You Should Avoid 12b-1 Fees

High Expense Ratios and the Impact on Retirement Savings

A not-so-fun fact: baking in 12b-1 fees means your expense ratios are higher.

Now, this wouldn’t be an issue if 12b-1 fees guaranteed higher fund performance, justifying added expense with added returns. Unfortunately, 12b-1 expenses reduce fund returns.

The Securities and Exchange Commission (SEC) found that 12b-1 fees brought in more money to a fund, but its shareholders didn't benefit from it. The idea was that having more assets would benefit shareholders by through economies of scale. However, in reality, shareholders often paid more to expand the fund. Meanwhile, it was the fund company or advisor who benefited from the increase in assets.

12b-1 fees can significantly reduce long-term performance, potentially lowering your employee's chances of a successful retirement.

Let’s take a look at an example:


Imagine an employee named Roger, who is 30 years old. He contributes $4,000 annually and earns a 6% yearly return. Roger will have $291,000 when he turns 65, with all fees included totaling 1.9%.

If Roger changes to a plan with lower fees (0.6%), he will have $390,000 in his account when he turns 65.  

By lowering fees,  Roger could potentially have 34% more money at retirement.  New investors should be curious about what high 12b-1 fees could cost them over their investing lifetime.

Here’s another example comparing three different plans:

Table showing the impact of fees on retirement

‍Curious if you’re paying 12b-1 fees in your 401(k)?  Upload your fee disclosure to receive a free 401(k) fee analysis personalized to your business.

12b-1 Fees Lack Transparency

12b-1 fees are far from transparent. While each fund's prospectus discloses these fees, it does not reveal who receives the fee.  

Knowing how much you're paying your advisor or what you're paying for is not easy. This is because of how 12b-1 and other fees work.

It's hard to know if your financial advisor is worth the fee without knowing how much the fee is.

Uneven Fee Distribution

Under normal circumstances, not every fund in a lineup will charge 12b-1 fees.  Participants can distribute their assets differently among funds, causing uneven distribution of 12b-1 fees among them.

Conflict of Interest

One of the biggest problems with 12b-1 fees is the built-in conflict of interest.

How can you trust your advisor's fund suggestions when they benefit financially from recommending funds with high 12b-1 fees?

Even if your advisor or broker seems trustworthy, they still have a reason to choose funds that benefit them financially.

At ForUsAll, we are a 401(k) fiduciary that charges a set fee, no matter which investment options your participants choose. We don't take 12b-1 fees or sales commissions. We base our advice solely on what we believe is best for you.  This setup lets us eliminate conflicts of interest and provide your participants with the best options for their retirement success.

How can I determine if someone is charging me a 12b-1 fee?

Locating this information isn’t too difficult. There are two places to look:

Search both documents to find any 12b-1 fees. A table will generally list these fees, showing the mutual fund expense ratios.  Your 401(k) recordkeeper's 408(b)(2) fee disclosure should show who is getting 12b-1 fees, also known as "indirect compensation".

Finding fee disclosure documents can be difficult because recordkeepers don't always make it easy. Visit our page for step-by-step instructions on how to find it.

Stop paying costly 12b-1 fees

12b-1 fees can be opaque, confusing, and hard to decipher. That’s not how saving for retirement should work.

At ForUsAll, it’s our perspective that when it comes to fund management, transparency, accountability, and efficiency should be the standard. Why use 12b-1 payments and revenue sharing if there are easier ways to pay financial advisors and brokers?

Download 401(k) Benchmarking Guide
Save valuable time and quickly benchmark your plan to make sure you are not overpaying.
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About Author -
David Ramirez, CFA

David Ramirez, CFA, is a recognized 401(k) expert with over 20 years of experience in 401(k), ERISA, cash balance plans, and ESOPs. A UC Berkeley graduate, he played a pivotal role at Financial Engines, a 401(k) advisory firm founded by Nobel Laureate William Sharpe, Ph.D., where he was a portfolio manager who helped manage over $50B in 401(k) assets.  His clients included some of the largest Fortune 500 companies and state governments.

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This material has been prepared for informational and educational purposes only and should not be construed as a recommendation by ForUsAll, Inc., its affiliates or employees (collectively, “ForUsAll”)  to activate a cryptocurrency window or invest in crypto.  Investing in crypto can be risky and investors must be able to afford to lose their entire investment.  You should consult with your own advisers before activating a cryptocurrency window or investing in crypto.  ForUsAll does not provide legal, tax, or accounting advice. Please refer to your Plan's fee disclosure for more details.© 2023 ForUsAll, Inc. All rights reserved.
1 Schwab 2022 401(k) Participant Study - Gen Z/Millenial Focus, October 2022.
2 As of 12/31/2022. Employees include both current employees and terminated participants with a balance.
3 "Morgan Stanley At Work: The Value of a Financial Advisor" Morgan Stanley, March 2022.
4 Sarah Britton was a client when she provided this testimonial through an independent third party review website. She received no compensation for her remarks. There are no known conflicts of interest in the provision of her comments related to the services provided.