Self-directed brokerage accounts (SDBAs) within a 401(k) plan typically offer participants the ultimate investment smorgasbord: a virtually unlimited selection of stocks, bonds, exchange traded funds (ETFs), and mutual funds to feast on. Yet relatively few sponsors — only 16% of plans on the platform of one of the largest 401(k) recordkeepers — offer them.
Pros and Cons
If you don’t currently offer a brokerage option, you might at least consider the pros and cons of doing so. Ruling it out instinctively could be a disservice to plan participants, whose interests you’re charged with safeguarding.
The most common argument against offering SDBAs is the concern that participants electing to use them will make unwise investment decisions, overloading on “hot” stocks that crash and burn promptly after they invest. But is that a father-knows-best approach consistent with your operating philosophy? And, more to the point, is that worst-case scenario probable?
The principal argument in favor of offering an SDBA option is this: Plan participants should have the chance to create a customized retirement portfolio. Some have enough financial knowledge to assume the responsibility of either making their own detailed investment decisions, or retaining a professional investment advisor to assist them with the task. Some participants, particularly the older ones and those with substantial account balances, may indeed benefit from investment opportunities not available to them under your existing array of options.
The counterargument that participants can, if they want to buy individual securities, do so on their own outside of the 401(k) plan is valid only when those participants have substantial savings outside the 401(k). Even relatively wealthy participants often have most of their investable assets held within their qualified retirement plans.
An additional argument for SDBAs is that, when participants are defaulted into qualified default investment alternatives like target date funds, inertia takes over and they typically stick with that arrangement. That means that participants who would actually switch assets to an SDBA may be limited to those who are particularly motivated to exploit the opportunity. Casual investors wouldn’t simply drift into an SDBA. Plus, you can limit the proportion of funds that participants can transfer into one.
In any case, choosing to offer a brokerage option is a fiduciary decision for sponsors. This requires plan sponsors to ask:
- Would an SDBA give participants an opportunity to craft retirement portfolios in a way that they cannot with our existing investment lineup ― that is, would it actually fill a gap?
- Are a significant number of participants interested in having this option?
- Is it probable that participants are sophisticated enough either to rationally choose investments or to engage a registered investment advisor to support them in their investment selection decisions?
- Are brokerage services available that the plan can incorporate and that have a good track record for service quality and competitive fees?
- Would participant brokerage assets be properly held in secure accounts?
Only after carefully reviewing these issues and speaking with your employee benefits attorney should you consider moving forward with an SDBA option.
If you do add an SDBA, you’ll have the same ongoing monitoring duty for that option as for others in your plan. According to a Department of Labor (DOL) “field assistance bulletin,” fiduciaries must periodically review, among other things, any changes in the information that served as the basis for the initial selection of the provider. This includes determining whether the provider meets both applicable federal and state securities law requirements.
However, under the DOL’s 404(c) regulations, you wouldn’t be held accountable for poor investment decisions made by plan participants — as is the case with other plan investment options ― provided that you’ve given participants a “broad range” of choices, as described in those regulations.
If you decide to add an SDBA option, consider encouraging participants who select that option to create their own investment policy statement, just as plans and fund managers do. If they follow through, the exercise could help them make the most of the SDBA opportunity, and avoid its potential pitfalls.