Self-directed 401(k) brokerageaccounts: What you need to know.

Self-directed brokerage accounts, which were a popular additionto larger 401(k) plans in the 1990s, are beginning toregain popularity in the professional plan marketplace.

Brokerage accounts allow plan participants to choose from abroad range of investment options and gives them greater controlover their plans.

Reportedly, only 20 percent of employers who offer a 401(k)plan include a brokerage window in the design. This is partlydue to cost considerations, lack of interest on employees' partsand desire to keep things simple.

With added scrutiny on plan sponsor oversight, higher feestructures and low participation rates, companies consideringadding a brokerage option to their 401(k) plan need to tread cautiously andunderstand their ongoing responsibilities with respect to brokeragewindows.

Interest in self-directed brokerage options

The introduction of brokerage windows coincided with increasedonline access. Employees could more easily check on their balances,move between funds and keep an eye on the overall market.

Many HR departments received requests for a broader range ofinvestment choices, reflecting an array of asset classes and sectorfunds. So the new brokerage feature appealed to those who wantedtotal control of their investments in the 401(k) plan.

Accordingly, the windows have proven to be popular with someemployees for the freedom of choice presented.

However, overall usage is typically limited, with participantstending to be more senior-level, older and/or higher paid. Only4 percent of workers with access to thebrokerage option use it (8.3 percent of those earning over $100,000do).

Why brokerage options aren't a top priority

Businesses develop their benefit plans to be competitive bothwithin their geographic area and their industry.

These days, a retirement savings plan is a must for medium tolarger firms in nearly all arenas, and for smaller businesses insome industries. However, when job candidates weigh benefitspackages, a brokerage window is not a selling point.

People are far more concerned about a company match, vestingschedules, that there be varied fund choices and wait periods forparticipation.

Given the low usage, having a brokerage account option is not avariable for attracting or keeping good employees. If someone has alarge rollover balance from a previous employer, they can easilyinvest it with a brokerage account on their own.

Brokerage window funds typically have higher fees.

Many recordkeeping service providers charge additional fees forthe service (typically at the participant level). Additionally,indications are that returns in brokerage accounts are most likelynot higher. The S&P 500 stock index outperformed 79 percent of large-cap fundmanagers in 2011.

Also, research shows that defined benefit plans outperformdefined contribution plans. From 1995 to 2011, the difference averaged 76 basis points.

An additional concern with having a self-directed option or evena vast assortment of funds in a 401(k) is employee confusion overhaving too much choice. A 2016 Wharton study showed that having too manyfunds from which to choose confuses participants.

Additionally, those plans that have reduced their fund menu havefound that participants choose lower fee funds and make fewertrades than before. They reportedly save over $9,400 over a 20-yearperiod.

Cost considerations and the regulatory environment

In recent years, fees have been a contentious issue for 401(k)plans and other investment options.

This has included several lawsuits, including one that reachedthe U.S. Supreme Court two years ago. The Supreme Court ruling inTibbleV. Edison (2015) determined that Edison International actedimprudently by offering six retail-class mutual funds in their401(k) when materially identical institutional-class funds withlower fees were available.

The plan had approximately 50 funds available, including morethan 40 with lower fees, but having some that weren't the lowestbreached the company's fiduciary responsibility.

For many plan sponsors, the quarterly review of the standardinvestment menu is tricky. What does the plan sponsor do if theysee a huge gain or loss? If they start the review of the returns ina window, they could open Pandora's box.

Additionally, does offering brand-name funds through a windowcreate a problem if institution-class versions are available?

Besides the lawsuits, the fee issue resulted in an Obamaadministration Department of Labor (DOL) ruling on the fiduciaryresponsibility of investment advisors and plan sponsors acting onemployees' behalves introduced.

While the DOL ruling implementation has been delayed by thecurrent administration, many sponsors and record keepers hadreviewed their agreements and plan designs to minimize risks basedon funds offered, particularly with regard to fee disclosurerequirements.

Plan sponsors (employers) are always at risk from acomplaint/lawsuit related to the investment menu, with or withoutbrokerage accounts.

One can argue that requiring a participant to sign an extra formbefore they select the brokerage account indicating they are 100percent responsible for their investments might help.