Self-Directed Brokerage Accounts in 401(k) Plans

401(k) plans typically allow participants to choose their investments from a limited set of funds (often 12 to 20 choices) that are selected and monitored by the plan sponsor. Some plans, however, choose to offer self-directed brokerage (SDB) accounts, also known as “brokerage windows,” which allow their participants to choose to invest in almost any publicly available investment.

SDB accounts are somewhat controversial. Proponents of these accounts believe that the vast expansion of investment options is beneficial to plan participants, especially those who are sophisticated investors. Opponents have offered up the following criticisms, among others:

  • If participation in SDB accounts is limited to specific categories of employees or to participants with minimum asset balances, it may be discriminatory.
  • Even though participants in SDB accounts have almost unlimited choices, the plan sponsor may still have a fiduciary duty to monitor investments within those accounts, for example by making sure that participants do not select a mutual fund with an inappropriately expensive share class.
  • Depending on the nature of the fee structure, there might be a situation where the core investments subsidize the administrative costs of the SDB option.
From a practical standpoint, we have worked with numerous plans that maintain SDB accounts and here are some of the issues that we have seen arise:
  • Plans need to be very careful to avoid conditions for participation in SDBs that result in de facto discrimination in favor of highly-compensated employees. Examples might include making the option available only to physicians, or only to participants with balances in excess of $100,000.
  • As we suggested in a previous post, it is a good idea to disallow the purchase of limited partnership interests within SDB accounts, because these investments can result in unrelated business income, which in turn can result in unwanted tax obligations and tax return filing requirements (specifically, a Form 990-T with an April 15 due date.). If tax is owed, it would need to be charged to the participant’s individual account, which could be administratively onerous.
  • Plan sponsors such as law and accounting firms that are subject to significant conflict-of-interest rules need to be careful that no investments in SDB accounts give rise to a conflict. For example, a CPA firm that offers an SDB option in its 401(k) plan needs to make sure that no participant uses his or her SDB account to invest in one of the firm’s attest clients.
The Department of Labor recently announced that it is reviewing the use of SDB accounts in participant-directed retirement plans such as most 401(k) plans, and has asked the public to comment on these arrangements. Comments are due on November 19, 2014. This is likely a prelude to new regulations or other guidance regarding SDB accounts. It is obviously impossible to be certain about the nature of such guidance, but some possibilities include:
  • Requirements of additional disclosures, for example of standardized investment performance or benchmarking information
  • Prohibition of offering SDB accounts in the absence of a diverse core lineup that complies with ERISA Section 404(c)
  • Additional reporting requirements on Form 5500
It seems unlikely that the Department will eliminate the use of SDB accounts in 401(k) plans and other qualified defined contribution plans, but any new regulations might have a very significant impact on how SDB accounts operate. In the meantime, SDB accounts can be a useful option in certain situations, but they are not without potential pitfalls and should not be entered into lightly.

E. Drew Cheney Posted By
E. Drew Cheney

Posted Under: 401(k) plans, fiduciary duty, self-directed brokerage account

Share this post: