What is a Mutual Fund 12B-1 Fee

A mutual fund 12b-1 fee is a distribution and/or annual marketing fee.  The 12b-1 fee is designed to be an operational expense and, as such, is included in a fund’s expense ratio. It is usually between 0.25 and 1% (the maximum allowed) of a mutual fund’s net assets. The 12b-1 fee gets its name from a section of the Investment Company Act of 1940.

Breaking Down the 12B-1 Fee

Many years ago in the early days of the mutual fund business, the 12b-1 fee was widely thought to help investors. It was accepted that by marketing a mutual fund, its assets would increase and management could lower expenses because of economies of scale. This has yet to be proven. With mutual fund assets passing the $10 trillion mark and growing steadily, critics of this fee are seriously questioning the justification for the continuing use of it. Today, the 12b-1 fee is mainly used to reward financial advisors and brokerages for selling a fund’s shares. As a commission paid to salespersons, it is currently believed to do nothing to enhance the performance of a fund.

In 2015, the Securities and Exchange Commission (SEC) began examining the use of 12b-1 fees to determine if the rules for charging these fees are being adhered to and the presence of such fees is being properly disclosed.

Breakdown of 12b-1 Fees

The 12b-1 fee can be broken down into two distinct charges: the distribution and marketing fee and the service fee. Total 12b-1 fees charged by a fund are limited to 1% annually. The distribution and marketing piece of the fee is capped at 0.75% annually, while the service fee portion of the fee can be up to 0.25%.

Use of 12b-1 in Broker-sold Shares

Class B and class C shares of broker-sold mutual funds typically have 12b-1 fees, but they may also be charged on no-load mutual fund shares and class A broker-sold shares. 

Class A shares, which usually charge a front-end load but no back-end load, may come with a reduced 12b-1 expense but normally don’t come with the maximum 1% fee. Class B shares, which typically carry no front-end but charge a back-end load that decreases as time passes, often come with a 12b-1 fee. Class C shares usually have the greatest likelihood of carrying the maximum 1% 12b-1 fee. The presence of a 12b-1 fee frequently pushes the overall expense ratio on a mutual fund to above 2%.

What 12b-1 Fees Are Used For

The distribution fee covers marketing and paying brokers who sells shares. They also go toward advertising the fund and mailing fund literature and prospectuses to clients. Shareholder service fees, another form, specifically pay for the fund to hire people to answer investor inquiries and distribute information when necessary, though these fees may be required without the adoption of a 12b-1 plan. Another category of fees that can be charged is known as “other expenses.” Other expenses can include costs associated with legal, accounting and administrative services. They may also pay for transfer agent and custodial fees.

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