More retirement plans offering self-directed brokerage accounts

Defined-contribution plans are adding self-directed brokerage accounts as a way of giving participants more choices even as some plans reduce the number of core investment options.

Among those making the move are Sprint Nextel Corp., which began offering a brokerage option in its $2 billion 401(k) plan in October; Stanford University, which opened a window in its $3.6 billion 403(b) plan in November; Hawaii’s $1.45 billion 457 plan, which launched its self-directed operation in April; and the Ohio Public Employees Retirement System, which will offer the option in its $373 million 401(a) plan next spring.

DC plan executives “want more simplicity in the core offerings, and [self-directed investing] has become an outlet for people who might be unhappy with the changes or who want more choices,” said Pam Hess, director of retirement research at Hewitt Associates LLC.

Hewitt’s research shows a steady rise in the use of self-directed brokerage. Tracking results every two years since 2001, Hewitt found that the percentage rose steadily to 26% last year, from 12% in 2001, among midsize and large companies.

Last year, a survey of 285 Hewitt and non-Hewitt clients showed that self-directed brokerage accounts represented 3% of assets in plans in which the option was available.

“The primary drivers are the participants with the highest income and highest account balances, and the longest tenures,” said Stacy Schaus, senior vice president for DC practice at Pacific Investment Management Co. LLC. “People who use it are typically working with a financial adviser.”

Ms. Schaus’ comments are supported by a 2010 Hewitt survey showing that higher salaries are linked to higher participation in self-directed brokerage accounts. That survey showed that 10.4% of participants who earn more than $100,000 annually used the option last year, compared with 1.5% of those who earn $20,000 to $39,000 a year.

Some self-directed brokerage accounts are restricted to mutual funds; others allow participants to invest in individual stocks and bonds, as well as mutual funds and exchange-traded funds.

“This gives sophisticated investors more options” than are available in a typical DC plan, said Ryan Alfred, president and co-founder of BrightScope Inc., which rates 401(k) plans. The accounts also can mollify the small group of vocal investors in any plan who chafe at what they see as limited choices, he said.

Some plans charge an annual administrative fee to users, and users pay all transaction costs. All expenses are paid from account balances.

Plan officials must emphasize to participants that the transaction costs incurred by the relative few who use the brokerage option won’t be borne by everyone else, said Ken Etheredge, senior vice president and retirement plans practice leader for BOK Financial Corp., which sets up self-directed brokerage accounts.

“You can’t pass that cost to other participants,” he said.

When BOK Financial establishes a self-directed brokerage account for a client, it makes sure that participants sign an agreement saying that they understand the fees as well as the risks and the limits on their investments, Mr. Etheredge said.

“You have to acknowledge that you understand when you step outside the house of the 401(k) and into the window” of self-directed brokerage, said Maxine Sandman, manager of investment analysis at Sprint Nextel.

The self-directed option accounts for less than 1% of the company’s 401(k) plan assets, she said.

“It was an opportunity to give a choice to participants who were interested in funds that were not appropriate” for the general employee population, said Ms. Sandman, referring to sector funds. Sprint Nextel participants can invest in mutual funds and ETFs.

Installing the brokerage option was part of a restructuring that included shifting to target date funds from risk-based ones, offering more passive funds and reducing investment options to 20, from 28.

“We wanted to simplify to make it easier to educate participants,” Ms. Sandman said.

Officials eschewed making stocks available “because of the risk of the participant’s portfolio becoming non-diversified,” she said.

At Stanford University, launching the brokerage plan also was done in conjunction with a restructuring. Stanford officials reduced the number of mutual funds in its 403(b) plan to five core funds and a series of target date funds, from 295, said Leslie Schlaegel, associate vice president for benefits.

The previous investment lineup “was too confusing for participants,” he said.

The brokerage option gives participants access to more than 4,500 mutual funds.

“By regulation, 403(b) plans can only offer mutual funds … no individual stocks,” Mr. Schlaegel said.

About 17% of plan assets are invested through the option of self-directed brokerage, he said.

Hawaii’s DC plan allows brokerage users to invest in stocks, bonds and mutual funds, Cynthia Akiyoshi, personnel management specialist for benefits administration in Hawaii’s Department of Human Resources Development, wrote in an e-mail.

“Over the years, the plan’s board of trustees received inquiries from plan participants on including various types of investment options, so the board decided to expand the choices of investment options,” she wrote.

Less than 1% of plan assets are invested through the brokerage option, Ms. Akiyoshi wrote.

At the Ohio Public Employees Retirement System, “we wanted a diversified portfolio,” so the plan’s brokerage option will offer mutual funds and not stocks, said John C. Lane, director of investments.

The brokerage account option will be available in the spring, according to Eric Sanderson, the system’s DC plan manager. Participants must have at least $5,000 in plan assets, and the brokerage account can hold only 50% of a participant’s assets.

Mr. Sanderson expects the option to feature 6,000 to 12,000 mutual funds.

Meanwhile, executives at other plans are allowing even more latitude for brokerage units.

When the $1.7 billion Southwest Airline Pilots Retirement Savings Plan started a self-directed brokerage account 20 years ago, participants could place 25% of their assets in it, said Richard Doherty, benefits director and 401(k) administrator. In January, the limit was raised to 95% as part of the pilots’ collective bargaining agreement with Southwest Airlines Co.

“The company was concerned [about raising the limit], but we showed them that no one was day trading over the last 10 years,” Mr. Doherty said.

Pilots can invest in stocks, bonds and mutual funds, but they can’t trade in master limited partnerships or penny stocks, he said.

About 10% of plan assets are in the brokerage option, and about 20% of participants use the option.

“The pilots here hope to have a 30-year career,” Mr. Doherty said. “Having better retirement choices takes pressure off wages.”

Southwest officials also are “looking at a similar product” for the company’s $2 billion 401(k) plan, said June Jackson, manager of retirement benefits. She declined to elaborate.

Robert Steyer is a reporter for sister publication Pensions & Investments.