Contingent Deferred Sales Charge (CDSC)
A contingent deferred sales charge (CDSC) is a back-end sales charge paid when mutual fund shares are redeemed, and it declines the longer the shares are held, eventually reaching zero.
The SIE® ties the CDSC to Class B shares. A Class B investor pays no front-end load, so the full deposit goes to work on day one, and pays a charge only for leaving early. “Contingent” is the operative word: the charge depends on when the investor redeems, and an investor who never redeems early never pays it.
The declining schedule
A typical schedule starts at 5% for redemptions in the first year, following the same breakpoint-style declining-scale logic funds use elsewhere, and drops about one percentage point per year until it hits zero after year five or six. Once the CDSC has run off, Class B shares typically convert to Class A, so the investor picks up Class A’s lower 12b-1 fee from then on.
Worked example
An investor puts $10,000 into Class B shares. All $10,000 is invested on day one, because nothing is deducted at purchase.
She redeems in year two, when the schedule reads 4%. On the SIE, the stated percentage is applied to the amount redeemed, so a full redemption of the $10,000 position costs 4% × $10,000 = $400, and she receives $9,600.
Compare the same $10,000 in Class A shares carrying a 5% front-end load. The load takes $500 immediately, so only $9,500 is ever invested, but a redemption in year two costs nothing.
Hold the Class B shares for seven years instead and the CDSC is zero. By then the shares have converted to Class A, and the higher 12b-1 fee that ran during the CDSC years has stopped.
The exam trap
The trap is reading “no sales charge at purchase” as “no sales charge”. Class B is not the cheap class. It defers the charge and, while the CDSC is running, charges a higher annual 12b-1 fee than Class A. A question that quotes a customer saying Class B must be cheapest because nothing was deducted up front is asking you to name both costs: the back-end charge and the higher ongoing fee.
The second trap is the suitability of a large Class B purchase. Class A breakpoints cut the front-end load as the investment grows. Class B has no front-end load to discount, so a large Class B purchase throws away a discount the customer could have had.
The third is class confusion. Class C shares can carry a small CDSC of their own, often 1% if redeemed within the first year, but Class C carries a level annual load and either never converts to Class A or converts only after a long hold, often eight to ten years, which is what makes it the short-holding-period class.
Related distinctions
A CDSC is a sales charge paid once by the investor who redeems. A 12b-1 fee is an annual charge taken from fund assets, and it is not a sales charge at all. An annuity surrender charge has the same declining shape but belongs to an insurance contract. The full picture of which class suits which investor lives under share classes.
Check yourself
An investor redeems a $20,000 Class B position in year three, when the fund's CDSC schedule reads 3%. What is the charge?
- $0, because Class B shares have no sales charge
- $600
- $1,000
- $600, plus a 3% front-end load paid at purchase
Show answer and explanation
Answer: B. $600.
3% × $20,000 = $600. Choice A is the trap that mistakes "nothing deducted at purchase" for "no sales charge"; choice C applies the year-one 5% rate; choice D invents a front-end load that Class B shares do not have.
A customer investing $250,000 for at least 20 years is steered into Class B shares. What is the problem?
- Class B shares may not be sold in amounts above $100,000
- The purchase forfeits the Class A breakpoint discounts available at that size
- Class B shares never convert to Class A
- There is no problem, because Class B avoids a front-end load
Show answer and explanation
Answer: B. The purchase forfeits the Class A breakpoint discounts available at that size.
At that size the Class A front-end load would be sharply reduced by breakpoints, and Class B has no front-end load to discount. Choice D is the trap: avoiding the front-end load is precisely the wrong goal when the load would have been discounted.
Practice it: mutual funds practice questions
