Self-Directed 401(k) Rules and Options
Self-Directed Brokerage Accounts Give 401(k) Investors More Options
If you are a hands-on investor enrolled in a 401(k), 403(b), or 457 plan you may be interested in seeking additional alternatives to your retirement plan’s core investment lineup. But if you are like the vast majority of Americans, you are probably unaware of an offering potentially available in your employer's retirement plan—the self-directed brokerage account (SDBA).
When you place your retirement savings in a self-directed brokerage account, your investments are allocated to investments apart from those available in the core plan. Most retirement plans offering a SDBA allow access to a network of mutual funds while others may even provide access to stocks, bonds, and ETFs. According to Aon Hewitt, approximately 40 percent of retirement plans offer self-directed brokerage account options. Aon Hewitt also found that only around 3 to 4 percent of retirement plan participants with access to SDBAs actually use this self-directed option.
Retirement savers using the SDBA option generally have higher income and higher plan balances with the average account balance of those using this option just under $250k.
How to Determine if Self-Directed Brokerage Accounts Make Sense for Your Retirement Savings
You prefer having greater flexibility. The self-directed brokerage account (SDBA) gives investors access to a wider range of investment choices than the default ones presented in your plan. If you are unimpressed or dissatisfied with the investment options available in your retirement plan, checking to see if a self-directed brokerage account is available is a viable alternative to simply settling with your core investment lineup.
SDBAs may come in the form of a "mutual fund window" providing access to thousands of funds to choose from. Some SDBA options give investors access to a more flexible “brokerage window” account that may allow you to invest in mutual funds, exchange-traded funds (ETFs) and even individual stocks and bonds. The main concept is to give you more choice if you are a hands-on investor.
You do not have to place your entire workplace retirement plan account in a self-directed brokerage account. Many retirement plans with an SDBA option allow participants to allocate a portion of their total retirement savings to these self-directed accounts. This can be beneficial if you are generally satisfied with your retirement plan’s overall investment lineup but would like to gain access to missing asset classes like emerging markets, international small cap, or alternative asset classes such as real estate and commodities.
Your current investment fund lineup has above-average fees and expenses. Workplace retirement plans are required to provide fee disclosures and it is important to understand the associated costs. Many large retirement plans give investors access to institutional funds with below average investment costs while other plans are hindered by excessive fees and expenses. The general trend in the retirement plan industry is leaning towards lower costs. But if the investments in your retirement plan at work are too expensive you can often find lower cost options in the self-directed brokerage account.
It is important to understand any associated fees or expenses associated with use of a self-directed brokerage account.
There are some potential disadvantages to investing your retirement dollars in an SDBA.
It takes discipline to manage your own retirement savings. Self-directed brokerage accounts are designed for advanced investors who know how to research and manage their investments. FINRA cautions investors that the additional choices associated with SDBAs come with additional responsibilities. Unfortunately, individual investors often fall victim to the “behavior gap” due to mistakes related to emotional decision-making. Some common investor mistakes can occur whether using core retirement fund options or self-directed brokerage accounts.
Having discipline as an investor typically requires a focus on things within your control such as asset allocation, contribution rates, minimizing costs, and asset location (i.e., pre-tax vs. Roth 401k).
Some retirement plan sponsors attach additional costs to the self-directed brokerage account. Many retirement plans charge an annual maintenance fee for using the mutual fund or brokerage window. There may also be additional commissions and transaction costs associated with trades made through SDBA accounts. For these reasons, it is important to always check your plan’s fee disclosure to fully understand the actual costs related to your current 401(k), 403(b) or 457 plan. In fact, reviewing your investment portfolio fees should be part of every investor's annual financial check-up.
It is also possible that the costs associated with mutual funds available through the SDBA may be higher than those in comparable funds within your plan's core menu. The reason for this is due to the fact that many large retirement plans offer investors access to institutional class mutual funds that typically have the lowest expense ratios compared to other mutual fund classes and are only available to investors with large account balances. Pooling your investment money with others through retirement plans at work is one way to gain access to these lower cost institutional shares.
You may already have access to low-cost professional investment management and guidance within your retirement plan. An increasing number of retirement plan sponsors offer professional investment management. Target date retirement funds provide hands-off investors with professional management and asset allocation. These increasingly popular mutual funds provide instant diversification with portfolios designed to gradually become more conservative as investors approach their targeted retirement date.
However, if your retirement plan does not provide access to target-date funds the self-directed brokerage can open this diversified fund alternative to your retirement savings.
Self-directed brokerage accounts are not available for everyone. As previously mentioned, less than half of retirement plan sponsors actually offer a brokerage or mutual fund window for plan participants. SDBAs are optional and it is up to your employer's retirement plan administrator to decide if they want to make the self-directed brokerage account available to an employee.
Your investment performance should always be viewed in relation to your overall retirement planning strategy and life goals. That is why it is important to establish important benchmarks to track your performance really lags, it should be thoroughly reassessed.