What Is a Contingent Deferred Sales Charge?

A Contingent Deferred Sales Charge (CDSC) is a fee investors may encounter with certain mutual funds. Unlike charges applied at the initial purchase, a CDSC is incurred upon the sale or redemption of fund shares. This fee structure is designed to influence investor behavior and compensate mutual fund companies for various costs. Understanding how these charges operate is important for mutual fund investors, as they can directly impact net returns. This overview clarifies CDSC mechanics and implications.

Fundamentals of Contingent Deferred Sales Charges

A Contingent Deferred Sales Charge (CDSC), also known as a “back-end load,” is a fee assessed when an investor sells mutual fund shares within a predetermined timeframe after purchase. The term “contingent” signifies that the charge is not guaranteed but depends on the timing of the redemption. If shares are held beyond a specified period, the charge no longer applies.

The “deferred” aspect means the sales charge is not paid at the initial investment but at a later point when shares are redeemed. This contrasts with “front-end loads,” which are deducted from the investment amount at purchase. Mutual fund companies implement CDSCs to discourage frequent trading and encourage a long-term investment approach.

The “surrender period” is the duration during which the charge remains in effect, typically five to eight years. If an investor redeems shares before this period concludes, a percentage of the redemption amount is deducted as the CDSC.

CDSCs primarily help mutual funds recoup upfront commissions paid to financial advisors. Advisors often receive a commission from the fund company when selling shares. The CDSC helps offset these initial distribution and marketing expenses if an investor sells shares before the fund recovers costs through ongoing fees.

Calculation and Applicability of CDSCs

CDSC calculation involves a declining percentage scale based on how long shares are held. The charge is applied as a percentage of the lesser of the original purchase price or current market value. A common schedule starts at 5% or 6% in the first year, decreasing annually until it reaches zero after five to eight years. This declining schedule incentivizes investors to hold shares longer, as the cost of early redemption diminishes. After the five to eight year surrender period, no CDSC applies.

CDSCs can be waived under specific conditions, even if shares are redeemed within the surrender period. Common waivers include redemptions due to the shareholder’s death or permanent disability. Documentation, such as a death certificate or physician’s note, is required.

CDSCs are also waived for:
Distributions from systematic withdrawal plans (SWPs), often up to 10% or 12% of account value annually.
Exchanges made within the same fund family.
Required minimum distributions (RMDs) from retirement accounts like IRAs and 403(b) plans. This ensures individuals can meet tax obligations without additional sales charges.

Investors should consult the fund’s prospectus for specific waiver conditions, as these vary by fund and share class.

CDSCs and Mutual Fund Share Class Structures

CDSCs are primarily associated with specific mutual fund share classes, such as Class B and Class C shares. Each class has a distinct fee structure, impacting when and how sales charges are incurred.

Class B Shares

Class B shares do not impose an upfront sales charge, so the entire investment amount is immediately put to work. They are subject to a CDSC if redeemed within five to ten years. The CDSC declines over this period, reaching zero. Class B shares can automatically convert to Class A shares after seven to eight years, once the CDSC period expires. This conversion is beneficial because Class A shares have lower ongoing annual expenses, including lower 12b-1 fees.

Class C Shares

Class C shares usually have a lower or no upfront sales charge, similar to Class B. They impose a smaller, flat CDSC for a shorter period, often one to three years.

While the CDSC is less burdensome in duration, Class C shares often carry higher ongoing annual expenses, particularly higher 12b-1 fees. These fees, used for marketing and distribution, can be as high as 1% annually. Unlike Class B shares, Class C shares do not convert to Class A shares, so investors continue to pay these higher ongoing fees as long as they hold the shares.

Class A Shares

In contrast, Class A shares feature a “front-end load,” a sales charge paid at purchase. A portion of the initial investment is immediately deducted as a fee. Class A shares do not have a CDSC. While they have an upfront cost, Class A shares often come with lower ongoing annual expenses and 12b-1 fees compared to Class B and C shares, making them more cost-effective for long-term investors. The differences in these share class structures highlight how mutual funds offer various ways for investors to pay for sales and services, making it important to align the chosen share class with individual investment horizons and preferences.