Go beyond a basic 401(k)

Go beyond a basic 401(k)

Give your employees more than just a 401(k), join the movement.

5 min read

Adding A Self-Directed Brokerage Window To Your 401(k)

David Ramirez, CFA
March 20, 2023
Adding A Self-Directed Brokerage Window To Your 401(k)
Table of contents

Is a brokerage window, also known as a self-directed option or account, a smart option for your company’s 401(k) plan? Basically, self-directed windows allow employees additional choice and flexibility to go beyond the limited investment options that makes up a retirement plan's "core" menu. For some companies adding a self-directed window may increase employee and drive higher engagement - while for other plans it could be an unnecessary feature that could be misused.

These days, there are some conflicting trends circulating in the 401(k) marketplace. On the one hand, academics have found that too many 401(k) investment options can lead to “choice overload.” That can cause employees to simply avoid making an investment selection and neglect investing for retirement. Reducing information overload is a big reason we like 401(k) automatic enrollment – done right, it can make getting into a retirement plan simple and easy. Researchers with the Pension Research Council talk a bit more about such behavioral biases, including avoiding decisions due to “information overload,” in an article “How Much Choice is Too Much? Contributions to 401(k) Retirement Plans.”

Anyone who has lost track of time in the cereal aisle or searching for a movie on Netflix can understand how too many choices might work against conscientious investing. Yet, despite increased awareness of the risks associated with a large number of investment options, a contrary trend has emerged: more plan sponsors are offering a brokerage window. According to Aon Hewitt, 40% of companies offer a self-directed brokerage window, up from just 16% in 2005.

While some employees embrace the chance to build a portfolio from a wide universe of choices, few employees actually take advantage of the opportunity. The same Aon Hewitt research reveals that only 3% of participants took advantage of the self-directed option when it was available.

The reluctance of employees to expand their choices seems to go hand in hand with the growing preference to invest in a limited number of target date funds. These “set it and forget” funds tweak asset allocations as investors move toward retirement.

In fact many investors invest in only a single a target fund. After all, these funds represent a balanced approach to long-term investment, and can be one of the best 401(k) investment options.

Cons of adding self-directed brokerage windows

Self-directed windows are ideally suited for employees that have the knowledge and sophistication to make their own investing decisions. If your plan does not have any employees that want (or are equipped) to make their own investment suitability decisions, then a self-directed window may not be the best fit for you.

Additionally, while self-directed windows are not considered part of a plan's core-menu (which the employer has a fiduciary responsible to select and monitor), according the Department of Labor, the employer still has the "statutory duties of prudence and loyalty to participants... including taking into account the nature and quality of services provided in connection with the platform or the brokerage window, self-directed brokerage account, or similar plan arrangement."

Risks to plan sponsors from self-directed brokerage

The Department of Labor does not prohibit sponsors from offering a brokerage window in 401(k) plans. In fact, even the Department of Labor's own retirement plan (the Federal Thrift Savings Plan) recently added a self-directed mutual fund window.

Plan sponsors should be aware, however, if a brokerage window will require increased recordkeeping costs, result in higher audit fees, or in any way add to plan expenses. The high fees may be justified, but if so, the plan sponsor should be able to explain and defend these expenses if necessary.

While the DOL may not spell out a prohibition against the brokerage window, the department has clearly become more interested in this investment option in recent years. Back in May 2012 the DOL issued a “Field Assistance Bulletin” that effectively warned sponsors not to use a brokerage window as a way to shirk fiduciary responsibilities regarding the appropriateness of a typical investment line-up. The Department of Labor does not want plan sponsors offering self-directed brokerage windows as a means to get out of fiduciary responsibilities.

Open or close the direct brokerage window?

Despite the risks inherent in offering participants self-directed brokerage, such an option may be entirely appropriate for your employees. The key is to determine whether or not such a platform is a good fit for your plan.

Go beyond a basic 401(k)
Give your employees more than just a 401(k), join the movement.
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About Author -
David Ramirez, CFA

David Ramirez, CFA, is a recognized 401(k) expert with over 20 years of experience in 401(k), ERISA, cash balance plans, and ESOPs. A UC Berkeley graduate, he played a pivotal role at Financial Engines, a 401(k) advisory firm founded by Nobel Laureate William Sharpe, Ph.D., where he was a portfolio manager who helped manage over $50B in 401(k) assets.  His clients included some of the largest Fortune 500 companies and state governments.

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This material has been prepared for informational and educational purposes only and should not be construed as a recommendation by ForUsAll, Inc., its affiliates or employees (collectively, “ForUsAll”)  to activate a cryptocurrency window or invest in crypto.  Investing in crypto can be risky and investors must be able to afford to lose their entire investment.  You should consult with your own advisers before activating a cryptocurrency window or investing in crypto.  ForUsAll does not provide legal, tax, or accounting advice. Please refer to your Plan's fee disclosure for more details.© 2023 ForUsAll, Inc. All rights reserved.
1 Schwab 2022 401(k) Participant Study - Gen Z/Millenial Focus, October 2022.
2 As of 12/31/2022. Employees include both current employees and terminated participants with a balance.
3 "Morgan Stanley At Work: The Value of a Financial Advisor" Morgan Stanley, March 2022.
4 Sarah Britton was a client when she provided this testimonial through an independent third party review website. She received no compensation for her remarks. There are no known conflicts of interest in the provision of her comments related to the services provided.