Not a Member? Get access to HR news and resources that you can trust.
Here is how HR can help prevent the missteps that could cost your company big in court.
Is your employee handbook ready for the changing world of work? With SHRM’s Employee Handbook Builder get peace of mind that your handbook is up-to-date.
Get the HR education you need without travel expenses or time out of the office.
Expand your influence and learn how to become an effective leader -- Join us in Phoenix, AZ, October 2-4, 2017.
'Brokerage windows' can greatly multiply the investment options in a 401(k) plan.
With Americans participating in the stock market at historic rates, it was probably inevitable that some employees would want the same investment flexibility in their retirement accounts as in their brokerage accounts.
In response, a growing number of 401(k)s are offering what is commonly referred to as a “self-directed account” or “brokerage window.” These allow participants to use their tax-qualified retirement savings to trade stocks, bonds or mutual funds as often as they want to within few, if any, limits set by the plan.
While several studies show that the percentage of employer plans offering self-directed accounts (SDAs) remains in single digits, there is evidence that the number of employers adopting or considering adopting these plans is increasing.
According to a 1998 survey by William M. Mercer benefits consultants of 303 large employee retirement plans, “7 percent of plan sponsors offer a brokerage window, up from 3 percent in 1997,” says Patricia Pou, principal and retirement practice leader in the Los Angeles office. “Another 7 percent said they planned to offer a brokerage window in 1999.”
John Doyle, vice president of marketing and communications for Baltimore-based T. Rowe Price Retirement Plan Services Group, says that although this option “is not widely used” among the company’s clients yet, “more and more companies are asking about it right now.”
Benefits experts and plan administrators agree that the main reason the number of plans offering SDAs is growing is because employees—especially those who are relatively sophisticated about investing—have asked for them. At Kalamazoo Anesthesiology PC, a medical practice in Kalamazoo, Mich., with about 85 employees, “the owners of the practice wanted to have control over not only what sort of asset allocation their retirement funds were going into. They also wanted control over the specific assets,” explained Rob Keller, administrator for the practice. About 50 employees are using the accounts, he says.
Ben Brigeman, senior vice president of Schwab Retirement Plan Services in Akron, Ohio, says the Kalamazoo medical group is representative of the sponsors that have adopted the Schwab version of SDAs—“the more professional groups such as doctors, lawyers, architects,” rather than large service or manufacturing industries. This experience is borne out by the
BARRA RogersCasey/IOMA 1999 Defined Contribution Survey published last April, which found more SDAs being offered by smaller employers than by larger ones. Of 448 responding plans, 12 percent with 250 or fewer employees offered self-directed brokerage accounts, compared with 9 percent overall.
Yet for many pension benefits experts, questions persist: Are self-directed accounts really a good option for most workers’ retirement savings, and should they be encouraged or facilitated by employers?
“Any professional money manager would tell people that the worst thing you can do with your retirement savings is to trade a good deal with them,” observes Martha Priddy Patterson, director of employee benefits policy analysis in the Washington office of Deloitte & Touche consultants. “On the other hand, I think certain people do feel that they need a lot of different investment choices.”
If your employees are asking for SDAs, consider the following key factors before making your decision: the types of accounts available and how you can customize them; administrative and operational issues; how to find the right vendor; and fiduciary risks and responsibilities.
Types of Accounts
The umbrella term “self-directed account” or “self-directed option” may refer to different types of accounts, Pou explains. “Depending on the type of investments made available, it could be a ‘broker window,’ which allows the employee to buy and sell publicly traded investments such as stocks, bonds and/or mutual funds, or it could be a ‘mutual fund window’ that allows investment in other mutual funds (outside the plan’s core offerings), but not in stocks and bonds.”
The parameters of these accounts may be negotiated with a vendor such as Fidelity Institutional Retirement Services Co. based in Boston. “We have capabilities to tailor what kind of investment options are available—to include or exclude equity, income or mutual funds,” says Senior Vice President Walter Twui.
Schwab, which calls its SDA option the “Personal Choice Retirement Account,” offers two versions that Brigeman calls, respectively, “a full brokerage window” that allows users to trade in securities and a “mutual fund window,” in which the sponsor offers the ability to trade in four or five families of funds.
In either case, SDA participants deposit money from their retirement contributions into a trading account and pay an annual fee for maintaining the account. They may be able to execute trades through the same channels they use for non-retirement accounts—on the Internet, through an automated phone order system, or through a broker. The employee pays about the same annual fee for an SDA as for a non-retirement plan account—between about $60 and $100 per year. Employees also pay their own trading commissions, which vary in cost depending on the vendor.
Therein lies one potential problem, according to Pou. “Suppose there is a $100 annual fee to keep the account open. If a participant is unsophisticated about investing and trans fers $1,000 into the self-directed account, they need to make over 10 percent just to pay for the fee.” And the 10 percent earnings will not even cover the costs of trading. Sponsors may require a minimum deposit in the SDA account—for Permanente Medical Group of California, it’s $2,500—but there’s usually no maximum specified.
Some sponsors prohibit riskier investments in options or commodities, on margin, in securities not under the control of U.S. law, in their own company stock, or in that of companies they do business with. But with few exceptions, experts say, most SDAs allow participants to invest as much of their retirement account as they want in a wide range of stocks, bonds or mutual funds.
Assuming you already have a 401(k), what are the administrative and operational implications of adding an SDA option?
First, make sure that an SDA would be consistent with your plan’s investment policy, suggests Jon C. Chambers, vice president of Schultz, Collins, Lawson, Chambers investment consultants in San Francisco. If you adopt such a plan, you may have to amend the policy. (See “401(k)s Need Investment Policies, Too,” October 1999
HR Magazine, p. 100.)
Chambers says vendors offer three different models for SDAs:
For more than 20 years Permanente Medical Group in California offered the third type of account, which was used by about 10 percent of plan participants successively in their Keogh, cash, deferral and then, 401(k) plans. Kathleen Riley, benefits supervisor for the group, says that each participant chose his or her own broker, and, each time a trade was executed, the participant and the broker had to forward information to the bank that served as trustee, to settle the transaction and wire funds to pay for it.
The system “just didn’t work the way it was supposed to,” Riley says. A big problem was the “manual environment,” which in just one year, when there were 500 participants, had to process more than 30,000 transactions including trades, cash transactions and postings of dividends. When Permanente decided to switch to a vendor with automated systems, Riley says, “we did not envision that we’d go into a self-directed option that did not allow participants to choose their own broker. But as it turned out, that made the most sense.”
Since 1996, Permanente has used Fidelity to administer all of its retirement plans, and finds that participation in the self-directed option has stayed around 10 percent. When some participants objected to having to shift their accounts (and brokerage commissions) from brokers they had selected personally, Permanente permitted them to continue to use their previous brokers as financial advisors and to pay them accordingly.
Full-service vendors such as Fidelity and Schwab say that if they are already managing your retirement plan, they can add a self-directed option to it with minimal additional paperwork, integrating the reporting into your existing system. In this case, Twui says, Fidelity’s usual quarterly reporting to plan sponsors would include an aggregate report on the SDAs, but not a report on the status of each individual account. “Sponsors also might have to put some additional information on the (government’s) Form 5500” for reporting on plans regulated under the Employee Retirement Income Security Act (ERISA), re quiring “some reconciliation by the auditors.”
Chambers, however, cautions that low fees and simple adjustments to audits are not always the case when you adopt an SDA: “As a plan sponsor, you are likely to pay more, but not for the reason you might expect. Your audit cost is going to go up significantly because the number of investments owned and the volume of transactions will skyrocket.”
Choosing a Vendor
“The bottom line,” Chambers says, “is that it really matters which vendor you go with. In our experience, a lot of plans are doing a vendor assessment by asking what the trading charge is, and going with the lowest cost. This is short-sighted, because some vendors will charge you the same fees they would charge to retail customers,” preventing plan participants from benefiting from economies of scale associated with large accounts. Although it may seem simplest to ask your current plan administrator to tack on the SDA option, Chambers says you should not assume that incumbency is the best qualification when you’re evaluating a vendor. He and other experts suggest considering these factors when choosing a vendor:
Without a reliable system for monitoring an SDA, you could be breaking the law without realizing it. Chambers cites the case of a 50-person tax-qualified profit-sharing plan that allowed all of its employees to have individual brokerage accounts. The company made its contributions every year, and the workers had a good relationship with the broker who managed the accounts. But at one point the plan sponsor realized that month after month, about half the workers were withdrawing a lot of the money from the brokerage accounts, which could have resulted in having the plan disqualified. There was no mechanism for ensuring that this did not happen. Plan sponsors realized what was happening before they got into trouble with Uncle Sam. But to correct the problem, they had, in effect, to make double contributions to those workers’ accounts.
Since money in a brokerage account is not normally under the control of the plan sponsor, Chambers says, the way to avoid this problem is to have a letter of agreement with the brokerage house spelling out exactly which account activities the broker must report to the sponsor.
Riley says that when Permanente switched its accounts from multiple brokers to one provider, the plan sponsor encountered another pitfall. Many participants had invested in “vehicles that were inappropriate for these accounts, such as annuities, life insurance wrappers and limited partnerships.”
Fiduciary Risks and Responsibility
Many plan sponsors fear that offering an SDA increases their fiduciary liability if something goes wrong with participants’ investments.
“There’s an underlying fear that if you give employees an unlimited range of investment options they could do anything with the money. And if they don’t do the right thing, they could blame you for offering it in the first place,” says Doyle of T. Rowe Price.
There is no easy answer. Under ERISA, fiduciaries of plans that elect to be covered by Section 404(c) are not treated as a fiduciary if they provide the conditions that allow plan participants to “exercise meaningful, independent control over the assets in their account.” In general, these conditions require a diversified choice of investment alternatives with different risk and reward characteristics, investor education and sufficient information to make informed investment decisions. As clear as these standards may appear, there is a broad spectrum of legal opinion on what they mean—especially in relationship to SDAs, which are not even specifically mentioned in the ERISA regulations.
Mercer’s Pou says that “one view of section 404(c) is that with a self-directed option you are giving total control and responsibility” to the participant to choose from virtually all investment options, and “on the opposite end—since there is not any specific guidance regarding these unlimited options,” some experts think that “fiduciary responsibility is actually greater.”
So, if your company wants to offer an SDA, what can you do to limit fiduciary responsiblity?
One answer is fiduciary insurance—a policy that “protects an employer or plan sponsor from litigation from participants in the plan or employees who allege a breach of fiduciary duty under ERISA,” explains Michael J. Maloney, vice president of the Executive Risk Division of Chubb & Son insurance in Connecticut. Maloney says that adding coverage of an SDA to a policy for your retirement plans probably would not increase the premium, because defined contribution plans in general are less risky than defined benefit plans and some other types of pension plans.
“The more choice of investments the employee gets and the more they get involved, the less potential liability falls on the shoulders of the fiduciaries,” Maloney says.
Deloitte & Touche’s Patterson suggests plan sponsors cut their risk by limiting the percentage of money that participants can switch from the 401(k)’s core options into a trading account. And some employers actually pay for SDA traders’ cost of getting expert investment advice.
But whether you talk to lawyers, plan sponsors or vendors, all agree that the most important strategy for operating an SDA option that complies with the law is providing extensive education to participants. If you offer an SDA, Pou points out, “you have to offer it to everyone in your plan. That means it will be available to less-sophisticated investors, maybe even some who don’t understand the basics of investing.” Keller says that the Kalamazoo group encourages participants to learn about investing by “holding educational sessions during work hours, providing access to good research, and paying for investment advisors out of the self-directed plan.”
Schwab’s Brigeman says that about 5 percent of participants in the company’s retirement programs opt for the SDA, and that 10 percent of plan assets are in these accounts. The average account size of $170,000 is about three times that of other accounts in the plans, suggesting that those who choose the brokerage option are more experienced investors than the average employee.
And that, says investment consultant Chambers, suggests what he believes are the two most important principles employees should be educated about:
SDA transaction costs, compared with the lower institutional rates generally available if the participant invests in the plan’s various mutual funds, can make a significant dent in your retirement earnings over the decades of your worklife; and
“These accounts are for people who have large account balances, investment expertise and the time and interest to invest properly.”
If you can get your employees to fully understand these principles—and if you offer them a good selection of mutual funds as an alternative—Chambers says, you’ll have the greatest protection of all: The majority of the participants will not bother to sign up for the accounts.
Ellen Hoffman is a Shepherdstown, W.Va., freelance writer specializing in retirement issues and the author of Bankroll Your Future: How to Get the Most from the Government for Your Retirement (Newmarket Press, 1999).
You have successfully saved this page as a bookmark.
Please confirm that you want to proceed with deleting bookmark.
You have successfully removed bookmark.
Please log in as a SHRM member before saving bookmarks.
Your session has expired. Please log in again before saving bookmarks.
Please purchase a SHRM membership before saving bookmarks.
An error has occurred
Recommended for you
CA Resources at Your Fingertips
SHRM’s HR Vendor Directory contains over 3,200 companies