What it means
The distinction between the plan and the fee is worth getting right. The plan is a governance document approved by the board and disclosed to investors, while the fee is the deduction from fund assets that the plan permits.
Adopting a plan is not a one-off act. The board is expected to review it at least annually, to receive information on what the money bought, and to satisfy itself that continuing the arrangement is in the interest of the fund's investors rather than only its distributors.
The plan names its components and caps them. Industry sales charge rules are commonly described as permitting up to 0.75% a year for distribution and up to 0.25% a year for shareholder servicing, giving a widely used combined ceiling of 1.00%.
A plan can also be terminated. Investors in the relevant share class, or the independent directors, can bring it to an end, after which the fund stops charging the fee even though the share class continues to exist.
For anyone evaluating a fund, the plan is useful evidence rather than paperwork. Reading how the maximum rate is set, what it is spent on and how often the board reviews it tells you whether the charge is actively governed or simply inherited from the day the fund launched.
The nuance that catches people out is that a plan sets a maximum, not an actual charge. A fund may have authority to charge 1.00% but only levy 0.50%, so the figure in the plan and the figure in the expense ratio are often different.
In practice
Real-world examples.
Example
A fund board reviewing its plan asks for a breakdown of the $3,000,000 charged in the prior year. The report shows that 80% went to platforms as continuing commission and only 20% to genuine marketing, so the directors cut the authorised distribution rate from 0.50% to 0.25%.
Example
A pension consultant screening fund menus for a corporate client reads each fund's plan disclosure rather than only the headline expense ratio. Two funds charge the same today, but one has authority to raise its fee to 1.00% without a new investor vote, so he recommends the other.
Example
A fund launches a new share class aimed at advisers who charge their own fees, and the board adopts no plan at all for that class. Because there is no authority to charge a distribution fee, the class is priced 0.75% a year below the retail class holding exactly the same portfolio.
Formula
Calculation
Annual cost of a 12b-1 plan to a fund = average net assets x (distribution rate + servicing rate)
Consider a fund with average net assets of $400,000,000 and a plan that permits 0.50% for distribution and 0.25% for shareholder servicing. The distribution element is 400,000,000 x 0.0050 = $2,000,000 a year. The servicing element is 400,000,000 x 0.0025 = $1,000,000 a year. The total charged under the plan is 2,000,000 + 1,000,000 = $3,000,000 a year, every dollar of which comes out of investors' assets and reduces the return they receive.Case study
Seen in the real world.
Thornbury Income Funds is an illustrative, fictional fund family whose flagship bond fund had operated under the same plan for more than a decade. The plan authorised 0.75% for distribution, which had made sense when the fund was growing quickly and needed to attract new money.
By the time the fund had stopped taking new investors, the fee was still being charged and still being paid out as continuing commission. At average net assets of $600,000,000 the charge came to 600,000,000 x 0.0075 = $4,500,000 a year for distribution that was no longer happening.
The independent directors terminated the plan for that share class and the expense ratio fell accordingly. The illustrative lesson is that a plan is a live governance obligation, and the board's annual review is where it either earns its place or should be ended.
Watch out
Common mistakes.
- Using the words plan and fee interchangeably, when the plan is the board authorisation and the fee is the amount actually deducted.
- Assuming the rate stated in the plan is what investors are paying, when many funds charge less than their authorised maximum.
- Believing a plan is permanent, when it can be terminated by the independent directors or by a vote of the relevant share class.
Questions
People also ask.
Who approves a 12b-1 plan?
The fund's board, including its independent directors, and the plan must be disclosed to investors in the fund's prospectus.
How often does the board have to look at it again?
At least once a year, with information on what the money was spent on and whether continuing the plan is still in investors' interest.
Does every mutual fund have one?
No, many funds operate with no plan at all, and the absence of one is usually why a share class or fund is noticeably cheaper to hold.
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