Reclassification

Reclassification is most commonly known as the process of changing a class of mutual funds. This can occur when certain requirements have been met or it may be caused by changes from the mutual fund company. In most cases reclassification is not considered to be a taxable event.

Reclassification can be used in open-end mutual fund structuring. It provides the mutual fund with some flexibility for managing share class features. It may also provide benefits to investors.

In open-end mutual funds, the fund typically issues multiple classes of shares. Each share class is structured with its own fees and sales loads. Some mutual fund companies may structure certain shares with reclassification provisions based on their duration. Class B shares are commonly converted to Class A shares after a specified period of time. (See also: The ABCs of Mutual Fund Classes.)

In the case of Class B shares, an investor could potentially avoid sales charges and pay a lower expense ratio after conversion. Class B shares commonly only incur back-end deferred sales charges which decrease over time. After a specified time period, these shares are often converted to Class A shares. The conversion is a non-taxable event, and the share class expense ratio is often lower for Class A shares, which is an added benefit for the shareholder.

Some fund companies may have certain requirements that trigger a share class reclassification. Vanguard provides one example with their Admiral Shares, which are intended for high-net-worth individuals. If an investor falls below the minimum investment, their shares are automatically reclassified to the fund’s Investor Share class.

Funds within a fund family may be reclassified due to exchange privileges. Exchange privileges allow investors to easily exchange share classes within a fund. They may also exchange shares to a new fund within the investment company’s fund offerings.

Some funds may choose to restructure share classes at their discretion. This can occur when operational changes affect the fund. Share class restructuring may also be the result of demand. A certain share class may have low demand, causing the fund company to merge it with another share class. A company might create a new share class for reclassification that meets demands from certain types of clients.

Companies can reclassify dividends paid which can affect an investor’s taxes. A fund company may choose to merge a fund due to low demand or performance. This type of reclassification can create a taxable event for the investor based on the price of share conversion when merged with the new fund.