I am writing an article about what 401(k) plan provisions that I think are mistakes and coincidentally, I was asked by a financial advisor about self directed brokerage accounts within 401(k) plans.
I used to joke that the only clients that used to ask about self directed brokerage accounts were medical practices and law firms. I stopped telling the joke when so many advisors told me that was the truth. My opinion about self directed brokerage accounts is like my view on smoking, it’s dangerous for your health and if that’s the path you want to take, so be it.
Since I work as an attorney for plan sponsors, I’ll be a little more specific. First off, most participants that opt for self directed brokerage accounts do worse than participants who utilize the investment options selected by the plan sponsors, as advised by a financial advisor. Second, I think there are compliance and liability issues for plan sponsors in offering them.
A major problem that plan sponsors have with self directed brokerage accounts is that they only want to offer it to highly compensated employees. Problem is there is something called benefits, rights, and features, meaning you can’t offer a benefit, right, or feature that discriminates in favor of highly compensated employees. A discrimination test has to be done, so only offering to highly compensated employees won’t work.
My other problem that I see for the plan sponsor is that I think most plan sponsors don’t do enough to cut down their liability in offering these accounts. I think plan sponsors need to advise participants interested in their accounts about the dangers of brokerage accounts within 401(k) plans and I think they should request a hold harmless agreement for those who opt for it. I always remember the guy who tried to kill himself by jumping in front of a New York City Subway who received a settlement from the MTA for injuries he received because he survived. Plan sponsors should put guidelines and agreements in place to minimize liability.
Another issue is that self directed brokerage accounts raises fees for 401(k) plans that offer revenue sharing funds because revenue sharing will not be applicable to individual stocks, bonds, options, or ETFs offered within a self directed brokerage account. Also, a financial advisor for the plan may charge a greater amount in fees because the financial advisor cannot assess a fee against self directed brokerage accounts if they don’t serve as the financial advisor for those accounts.
All and all, I don’t think brokerage accounts are a good fit 401(k) plans.