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Brokerage Windows: Do The Risks Outweigh The Rewards?

Brokerage Windows

Brokerage Windows: Do the Risks Outweigh the Rewards? More 401(k) and 403(b) plan sponsors are offering an investment option called a brokerage window. According to Aon Hewitt, 40% of companies currently offer a self-directed brokerage window, compared to only 16% in 2005. However, it doesn’t get a lot of traction — only 3% of participants took advantage of the self-directed option when it was offered, Aon Hewitt found.

The idea behind a brokerage window is to expand the number of investment options available in the plan. As its name implies, it allows participants to “self-direct,” or select their own investments inside of their retirement plan account. In a brokerage window, participants can choose from a broad array of investment types, but plan sponsors can limit those options, for example, by prohibiting the purchase of individual stocks.

However, more choice isn’t always better when it comes to the investment menu. In fact, it can cause participants to become overwhelmed by the number of options they have to choose from. Brokerage windows pose risks to both plan sponsors and participants alike. Option-laden investment lineups have also led to lawsuits in the 401(k) world (and similar lawsuits are emerging in the 403(b) arena).

Some sponsors have the misconception that offering a brokerage window relieves some of their fiduciary responsibilities. That is not the case, according to a recent blog post from retirement plan consulting firm ForUsAll. In fact, while the Department of Labor does not prohibit the use of brokerage windows in retirement plans, it has shown increased interest in them in recent years.

In 2014, the DOL issued a request for information (RFI) on brokerage windows “to learn more about what options are typically found in brokerage windows, who used it, what was the process for selecting the provider, and how much did these self-directed options cost. According to DOL, their goal in issuing the request for information was to ‘determine whether, and to what extent, regulatory standards or other guidance concerning the use of brokerage windows may be necessary to adequately protect participants’ retirement savings.’” Experts speculate that its heightened interest indicates the DOL could potentially adopt regulations around brokerage windows at some point in the future.

What’s more, the DOL has issued cautionary language in the recent past warning plan sponsors against using brokerage windows to shirk fiduciary responsibilities. In short, if you think offering a brokerage window in your retirement plan will make your life easier, think again.

Under current regulations, a brokerage window must be offered to all participants. However, the “self-direction” part is typically geared toward more experienced investors with the knowledge to choose and appropriately allocate their own investment options. As such, having the brokerage window available for everyone can be a drawback for novice investors, who may lack the knowledge necessary to make appropriate investment decisions. In other words, lack of experience may compromise participants’ investment performance, and consequently, their returns over time.

Further, plan sponsors should be aware if offering a brokerage window will result in higher recordkeeping costs and audit fees, or in any way add to plan expenses. While the increased costs may be justified, plan sponsors should be prepared to explain and defend them if necessary.

On the employee side, the risks are perhaps less obvious. Over-trading is one such risk. Employees may end up trading so often inside their accounts that commissions take a hefty chunk out of their returns, or they might buy high and sell low, which may further erode their investment returns.

ForUsAll aptly points out some of the risks to be aware of when it comes to brokerage windows. However, in the end, only you as a plan sponsor can decide whether or not offering a brokerage window in your plan is right for your employees.

Robyn Kurdek

Robyn Kurdek

Freelance writer with nearly 2 decades of financial industry experience, with niche expertise in the defined contribution (DC) industry. I also have defined benefit (DB) plan knowledge. I write all types of content for retirement plan participants, sponsors and advisors, including web copy, newsletters, white papers, fact sheets, blog posts, financial wellness articles, and more. "I speak DC."
Robyn Kurdek
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