Personalized 401(k) options: Is the desire for control & customization driving demand?

The desire for control and customization in retirement planning is driving the demand for personalized options within employer-sponsored 401(k) retirement plans. With an increasing number of employers now offering self-directed brokerage accounts (SDBAs) as part of their 401(k) plans, employees are enjoying more flexibility and control in their investment choices.

According to a survey conducted by Principal, over 80% of plan sponsors and financial professionals agree that personalized investment portfolios and managed account services will become common offerings within defined contribution plans by 2030. Recognizing this shift in employee preferences, many employers are incorporating SDBAs within their 401(k) plans, giving employees more control and flexibility in their investment choices.

SDBAs offer employees more control over their investments and access to a broader array of investment options, including individual stocks, bonds, exchange-traded funds (ETFs), and mutual funds. This flexibility allows employees to tailor their retirement portfolios to better align with their financial goals and risk tolerance.

Approximately 40% of American employers now offer the option of an SDBA within their 401(k) plans, according to Aon Hewitt. This trend is not limited to 401(k) plans, as some 403(b) plans have also started offering the SDBA option.

The role of financial advisors in optimizing retirement portfolios

Many SDBAs allow employees to hire a third-party investment advisor to manage their retirement accounts. This can be particularly beneficial for employees who lack the time, knowledge, or expertise to manage their investments effectively. Typically, an independent financial advisor will charge a fee ranging from 0.5% to 1.50% of the total funds under management per year. In some cases, these fees can be paid directly from the employee’s 401(k) account.

Hiring a financial advisor can add significant value to an employee’s retirement portfolio. A Harris poll found that 44% of Americans without financial advisors are now reconsidering engaging them after the devastating events of 2020. A good advisor can help employees navigate the complexities of SDBAs, create a personalized investment strategy, and potentially increase their overall investment returns.

How employers are addressing the demand for SDBAs

Adding an SDBA to an existing 401(k) plan is easy and does not typically add cost to the overall plan. The employer simply has to ask the custodian to add the option and then update the plan service agreement. Their third-party administrator may or may not charge the individual participant a fee for using an SDBA.

There is a fiduciary process for deciding to offer an SDBA and selecting the custodian. Still, it is typically quite simple, as outlined in a white paper by fiduciary attorneys Fred Reish and Bruce Ashton. Generally, the SDBA agreement already allows the participant to authorize their own third-party advisor to make trades on behalf of the participant. If not, that can be added.

Additionally, the employer should address the next step of allowing the third-party advisor’s fee to be deducted from the individual participant’s account to facilitate renumeration for their guidance and services. The fees can come from a participant’s outside investments; however, many participants have most of their retirement savings in their 401(k) account – not outside investments.

Fiduciary protection benefit associated with SDBAs

According to Reish and Ashton, if an employer allows the participant to choose their own advisor to manage their individual 401(k) account, the employer has no fiduciary liability for that advisor’s investment choices or results. On the other hand, if the employer selects and limits the advisors that can be chosen, they have a fiduciary duty to prudently select and monitor those advisors on an ongoing basis.

Related: Make it personal! Touting retirement plan options tailored to employees’ needs is key

The increasing demand for personalized 401(k) options reflects a shift in employee preferences towards control and customization in retirement planning. By offering SDBAs within their 401(k) plans and allowing employees to hire and pay for their own advisors, employers can cater to these preferences, attract and retain top talent, and support their employees’ long-term financial success. Providing these resources empowers employees to take control of planning and demonstrates the employer’s commitment to their workforce’s financial well-being.

Renée Pastor is founder of The Pastor Financial Group, an independent advisory firm with expertise in retirement planning and individual 401(k) management.