Self Directed Brokerage Accounts In 401(k) Plans: A Potential Headache

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.

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9 Responses to Self Directed Brokerage Accounts In 401(k) Plans: A Potential Headache

  1. Dave G says:


    How do you think employers with these type of brokerage accounts in 401(k)’s will/can comply with the new 2011 404/408 fee disclosures coming?

  2. Donald Davret says:

    There are several points in this article that I believe need to be segregated, and sifted through.

    Self directed investing, WHILE IT CAN BE DONE, requires an enormous sacrifice in time and research to asssure at least a chance of good results. With even talented professionals, who study the movements of the market as well as individual issues being no strangers to bad judgment, it would be a daunting task to manage a portfolio on one’s own, with the imited time available to devote to research. The bigger the portfolio gets, the more complex the management of it becomes. If professional and competent advice is rendered, a brokerage account could make sense for a 401(k), as the performance issue could be rendered moot.

    As for the matter of offering directed accounts only for the highly compensated, this need not be an issue- those with smaller amounts to invest would probably stick with the funds they would normally use anyway, and frankly, if an employee’s account has less than $50,000 in it, individual equity issues, for example, may not make much sense.

    As far as the fee issue, given the layers of hidden costs in the usual mix of 401(k)offerings of mutual funds and annuities, I would say the individual brokerage account would prove to be cheaper, especially over the long term. One pays a one time fee for a bond, for example, over the recurring fees of the other investments, which will cut into an investors ‘s total return over time.

    There has been a shift from actively managed brokerage accounts to fee-based ones over the years, with the rationale being that the fee based account will offer less incentive for the advisor to move assets around merely to generate commissions. However, this has resulted in a parallel curse: 401(k) accounts now languish for years, even decades, without the slightest attention given by the “wealth manager” who is supposed to maintain stewardship over the account. I have seen 401(k) accounts with the self same holdings (usually from a major fund house like Fidelity) through boom, bust and busted, without a single effort made to adjust allocation or holdings. In other words, advisors are now incentivized to do nothing.

    The far broader array of investment choices over the standard menu of funds gives a brokerage account a substantial investment edge as well. Most stock mutual funds seldom beat the averages, are grossly inefficient and wasteful, and worst of all, are over allocated in a retirement mix. Bond funds come preloaded with what might be a distastrous, pre-loaded interest rate risk that can hurt the investor at the very time they need the principle back. The ability to offer individual pieces which can be better allocated, cheaper to own, more sharply attuned to inherent risks, as well as better liquidity, can help the investor achieve superior results.

    And results is what it is all about. Every time I read one of these tomes on 401(k)s, I feel I have to remind the people who write them that the point of having a 401(k) is not just to have one. If the vehicle doesn’t give you more money at retirement than what you put in, there is little point in the exercise. And sadly, that is the very result millions of employees are living with right now.

    I have yet to see ONE rollover account that I would be personally proud of if I had managed it myself. And that is a disgrace.

  3. Ary, you make some good points, others that I might quibble with. I’ll keep it to one question: how do you feel about advisor-managed participant brokerage accounts within a 401(k)?

    • admin says:

      Skip, great question. Most of my problems with self directed accounts would be eliminated if there were an advisor leading the participant, but my concerns over the plan sponsor in terms of liability is still there.

  4. I hear from a lot of experts that returns in SDBA’s are inferior, yet I’ve have never actually seen hard evidence (a study) to support this. Where do you find support for your statement that “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.”?

    • admin says:

      Over the years, there were studies that showed SDBA returns were inferior and I saw it firsthand with the plan I handled.

  5. Roger levy says:

    Ari, Are not brokerage window accounts subject to the obligation of plan fiduciaries to monitor investment performance? And, if so, and they find imprudent investments, are they not powerless to intervene, leaving, as the sole option, termination of brokerage window option? I find little authority on these questions.

  6. Jim Rothaus says:

    Ari, how do you feel about only allowing the employee source of deferrals to be placed into a brokerage account. Does this help an employer or hurt one?

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